Preferred Habitat vs. Efficient Market: A Test of Alternative Hypotheses

Abstract

The standard Keynesian view is that actions taken by monetary authorities affect aggregate demand by altering interest rates. Since investment and consumption presumably depend primarily on intermediate and long-term rates and central banks operate primarily in short-term markets, a transmission mechanism is needed to explain how monetary policy affects aggregate demand. Expressing long-term rates as a distributed lag of short-term rates provides one such link.