Refer to Figure 1 below and answer the question that follows: Figure 1: Monetary Policy Transmission Mechanism Which combination best fits into boxes 2, 3 and 4, respectively?

Question

BlackTom AI · Accepted Answer

Monetary policy works by changing the target cash rate, which then alters market interest rates and thereby affects spending decisions such as investment.

1. Relevant knowledge points and concepts
- Central bank sets a target cash (policy) rate and uses open market operations to achieve it.
- Changes in the target cash rate lead to changes in short-term market interest rates and then to broader interest rates (loans, mortgages, corporate borrowing).
- Interest rate changes change the cost of borrowing and the return on saving, so they influence investment and consumption.
- Changes in investment (and consumption) shift aggregate demand, which then affects prices and real GDP.

2. Step‑by‑step reasoning process
- Box 1 states a change in monetary policy. The immediate instrument the central bank uses is the target cash rate (box 2).
- Altering the target cash rate changes liquidity in the interbank market and causes market interest rates to move (box 3).
- When market interest rates change, the cost of capital for firms and borrowing costs for households change; this changes planned investment spending (box 4).
- Lower interest rates → higher investment; higher interest rates → lower investment. That change in investment shifts aggregate demand (box 5) and ultimately prices and real GDP (box 6).

3. Calculations and intermediate steps
- No numeric calculations are required. The causal chain is qualitative: Change in policy rate → change in market rates → change in investment → change in AD → change in prices/GDP.

4. Why the correct answer is correct
- Option (a) exactly matches the monetary transmission chain: change in target cash rate (policy instrument), change in interest rates (market response), change in investment (spending response).

5. Why other options are incorrect
- (b) includes government spending, which is fiscal policy—not the immediate effect of a monetary policy change.  
- (c) lists change in budget deficit, again a fiscal variable unrelated to the immediate monetary transmission.  
- (d) reverses causality by putting “change in investment” before “change in interest rates”; interest rates change first and drive investment changes, not vice versa.

6. Conclusion
- Therefore the best-fit sequence for boxes 2, 3 and 4 is option (a): Change in target cash rate, Change in interest rates, change in investment. This matches the provided answer.

Refer to Figure 1 below and answer the question that follows: Figure 1: Monetary Policy Transmission Mechanism Which combination best fits into boxes 2, 3 and 4, respectively?单项选择题

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