Commercial loan rate

Other components of aggregate demand that may well be: for example, investment in stocks, consumer demand financed through credit cards, bank loans or hire purchase, and the demand for houses financed through mortgages . The problem of an unstable investment demand. Today the major worry about the interest-investment link is not that the investment curve is inelastic, but rather that it shifts erratically with the confidence of investors. Such confidence is highly volatile. For example, assume in Figure 18.7 that the authorities increase money supply and this lowers interest rates

1. Other things being equal, the level of investment will now rise, which in turn will later force the authorities to pursue a tighter monetary policy, their confidence may well decrease. The investment curve will shift to I 3 and the level of investment will actually fall to Q3. Monetary policy is only likely to be effective, therefore, if the government can " sell " it to the people, so that people have confidence in its effectiveness. This psychological effect can be quite powerful. It demands considerable political skill, however, to manipulate it. The Keynesian analysis of the exchange rate transmission mechanism The traditional Keynesian mechanism can be extended to an open economy to take into account international capital flows and movements in the exchange loan rate. 

The mechanism is still indirect. But this time it includes the exchange rate as an intermediate variable between changes in the money supply and changes in aggregate demand. There are four stages in the mechanism: 1. A rise in money supply will cause a fall in interest rates. 2. A fall in interest rates will lead to an outflow of short-term capital from the country. This will cause a depreciation of the exchange rate (assuming the authorities allow it to). 3. This will cause a rise in demand for exports and a fall in demand for imports. 4. This will cause a multiplied rise in national income. The four stages are illustrated in Figure 18.8. Stage 1 will tend to be more powerful than in a closed economy. The liquidity preference curve will tend to be less elastic. The reason is that, as interest rates fall, although people may buy fewer UK securities, they will not simply switch to holding idle balances of sterling.