The transmission mechanism of monetary policy in Keynesian economics is through :

Question

Accepted Answer

The correct option is 1:

In Keynesian economics, the primary channel through which monetary policy influences aggregate demand and, subsequently, output and prices is the **Rate of interest** (or interest rate channel). When the central bank implements an expansionary monetary policy (like buying bonds or reducing the policy rate), it increases the money supply, which in turn leads to a fall in the market rate of interest. This reduction in the interest rate lowers the cost of borrowing for firms (investment) and households (durable goods), thereby stimulating investment and consumption expenditure. The change in the interest rate causes a movement along the Marginal Efficiency of Capital (MEC) curve, leading to higher planned investment. This higher investment, magnified by the Keynesian multiplier, increases aggregate demand, helping the economy move towards full employment. Therefore, the interest rate serves as the crucial link between the monetary sector and the real sector of the economy.

The incorrect option is 2: Direct purchase
Direct purchase is typically a tool of monetary policy (such as open market operations where the central bank buys bonds) used to *change* the money supply and influence interest rates, rather than being the transmission mechanism itself. The mechanism describes *how* the change in policy affects the economy, which in the Keynesian model is primarily via the interest rate.

The incorrect option is 3: Wealth effect
While the wealth effect (changes in asset prices influencing consumption) is a recognized part of the transmission mechanism in broader modern monetary theory, it is not the primary or defining channel in the traditional, simple Keynesian model, which focuses on the interest rate's impact on investment.

The incorrect option is 4: Consumption effect
The consumption effect is part of the final impact *after* the policy has been transmitted (e.g., lower interest rates lead to higher consumer durable consumption), but it is not the *primary* transmission mechanism. The interest rate channel is the central linkage that causes changes in both investment and consumption.