Answer to Question #148001 in Macroeconomics for Francois

Question

The monetary transmission mechanism can be depicted in the form of a graph
or using symbols.
Explain, with the aid of symbols, the monetary transmission mechanism when
interest rates increase
(Note: Prices and wages are variable.) (10)

Answer 1

Monetary transmission occur as follows:

↑ Money supply →↓ Interest rate → ↑ Investment → ↑ AD → ↑ Y(real GDP)

With the rise in money supply, interest rates fall. This makes the investment to rise as the cost of borrowing funds fall. The investment rise raises the aggregate demand which in turn increases output or real GDP.