A government that practices concealment or deceit in matters that should be fair and open as day destroys public confidence and trust. Deceit is a false road to anything, including full employment. It does not work, especially not in such plain matters as the cost of living which every housewife is watching and appraising every day. Workers who are determined not to suffer reductions in their real wages cannot be led to suffer reductions through deceit. In fact, it is easier by far for government to deceive itself without perceiving it, then to deceive the people without their finding it out.
Having discussed the instrument and objectives of monetary policy, it remains to describe how policy influences the economy. This topic can usefully be divided up between the effects on economic activity, covered in this section, and the effects on inflation, covered in the final section.
In describing the processes by which monetary policy affects the economy, it should be kept in mind that they are far from being purely mechanical in their operation. Predictions about the effects of a policy action are, like economic forecasts generally, always subject to uncertainty. The task of policy is to make decisions on the basis of the best available information, recognising that these uncertainties exist.
The general principle that short-term interest rates affect aggregate demand and activity is illustrated in Graph 4. The pattern illustrated in the graph is that important changes in trend for a broad measure of demand have generally been preceded by significant changes in the level of short-term interest rates. Substantial rises in interest rates, designed to restrain inflationary booms, have been followed by contractions in demand. Conversely, substantial interest rate reductions have been followed by periods of significantly faster growth. In responding to cyclical developments and inflationary pressures, monetary policy has had a powerful influence on aggregate demand and economic activity.
We can identify several mechanisms through which these effects can occur, broadly grouped under five headings.