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The influence of money on aggregate spending in the spirit of the “theory of the multiplier” is challenged by a growing stream of literature on money and consumption in the studies of Hausmann, Del Sesto, and Galbraith. They show that money is a light cruet of liquid assets whose effect on aggregate expenditure is not so direct as to induce intense demand among the agents who are holding it. Instead, they try to argue that the money multiplier is largely a response that must occur through the channel of money as a means of payment that is associated with certain patterns of consumption. We argue that the multiplier channel is weakly supported and that the most likely explanation of the empirical regularities is the change in interest rate expectation that occurs as a result of the deviating monetary path. We will also show that the standard money theory of budget constraint is another aspect of the “passive channel” in that the closing of a monetary window, by changing the price level, will make it more likely that interest rates will be raised after the period of low rates have ended. Higher rates will then stem the flow of resource from the budget. This effect, we believe, is no more paradoxical than is the rise in prices that follows the contraction of the monetary base. A higher price level lowers the marginal product of money (MPM) that is the rate of monetary return. This effect, in turn, leads to a fall in interest rate expectations (and a rise in real interest rates) that gives rise to a budget constraint, which is “forced” by the new cash rate.
The classical “passive channel” of monetary transmission through the interest rate is discussed by Eichengreen, Hall, and Roberts (2002). Interest rates respond directly to changes in the money supply in the short run, but changes in the money supply do not fully account for changes in rates. From a theoretical standpoint, it is difficult to understand the dynamics of money, which are largely passive, in terms of the faster dynamic of markets. In this paper, it is argued that money lending is an integral part of the active behavior of the market-clearing system. The growth in the volume of money, or more properly, increased liquidity, leads to reductions in applied interest rates. d2c66b5586