The Impact of Monetary Policy on a Revised Version of "Consumer Spending"

Once upon a time in a faraway place, cattle was used for money. Alas, one black and gloomy day a wicked witch destroyed half the herd. With the fall in the supply of money, consumption of milk and meat declined. In such a golden age, it is easy to construct a link between the money supply (or monetary policy) and consumption. Thus to reduce the debate among economists, maybe the U.S. should switch to the bull standard. Until the fortunate day arrives, it is necessary to determine the less obvious links between monetary policy and consumption in both the short and long run. This paper will concentrate on the short run in which the appropriate definition of consumption is the purchase of durable and nondurable goods and services. Suppose for the moment that the monetary policy undertaken is an increase in the money supply.1 It is important to realize that such increases are not accomplished by the dropping of currency from a helicopter but by changing the monetary base through open market operations or through changes in reserve requirements. How could such changes in the money supply affect consumers? The four possible channels through which consumption could be affected are: wealth, interest rates, nonprice rationing, and consumer confidence. Let us consider in detail each of these possible routes.