Affect of monetary transmission:Most of the modern economists argue that this view of transmission mechanism is instead narrow. They say that similar to investment, consumption might differ with the interest rate. The classical economists supposed that consumption is inversely associated to the rate of interest. When we accept that view, a fall in the interest rate will cause a raise in consumption. As consumption is a component of aggregate demand, aggregate demand rises. This in turn, will raise the equilibrium level of income. When both consumption and investment rise, income will increase by more amount than when only investment rises.
The monetary economists further argue that monetary policy might also affect income by modifying total private wealth.
Total private wealth might be stated as society’s money supply, capital stock, and government debt (i.e., government debt comprises treasury bills, notes and bonds). And consumption is positively associated to total private wealth. When the nominal money supply raises and price level is constant, the real money supply rises. As it is a component of total private wealth, wealth rises, and in turn consumption increases. Whenever consumption rises, aggregate demand increases and the symmetry level of income increases. It might be observed that wealth and consumption rise without regard to modifications in the rate of interest. This follows that monetary policy is efficient even in the liquidity trap. According to Keynes, liquidity trap means to a situation in which an increase in the money supply does not outcome in a drop in the interest rate however merely in an addition to idle balances.
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