 I have already introduced the topic monetary policy transmission mechanism and I made it clear what transmission mechanism is and what are transmission channels. Now we in this lecture we will discuss first transmission channel that is interest rate channel. Now what is interest rate channel? First of all let us clear that the traditional model that you read the demand aggregate supply is also called as the traditional transmission mechanism channel, the interest rate channel why? Because the demand aggregate supply model that we were reading, whether it is the new classical model, whether it is the traditional model, whether it is the new Keynesian model when we change the policy and when we change the policy, we see what is the effect on the output, what is the effect on inflation and we were shifting the curves there. So the important thing behind that was the transmission channel, which was the transmission channel aggregate, demand aggregate supply model is the interest rate channel. So the importance of this channel is that this is why we call it a traditional channel that whenever we make a model in macroeconomics, then the channel that is working in that model whether we show it in the diagram or not, but the channel that is working always is the interest rate channel, for example. We keep seeing that if the demand aggregate curve is shifting on the right side because of you, then the policy maker tightens the policy and brings the aggregate demand curve back to the left side or to the old level. What does this mean? That aggregate demand can be reduced with the contractionary policy. Similarly, with the expansionary policy, the central bank or the monetary authority can increase the aggregate demand. So the question is that when the interest rate changes, which we call monetary policy decision with which the interest rate changes, then how does aggregate demand change? What is the mechanism? There are four components in aggregate demand. There is consumption, there is investment, there are government expenditures, there are net exports. So which component changes and why does it change? If we read this, then it will be called the interest rate channel. This means aggregate demand aggregate supply is of the interest rate of the channel, but we do not study this channel step by step. Now let's see the reason behind the transmission mechanism that why the aggregate demand curve shifts to the left when the policy tightens? Why does the aggregate demand curve shift to the right side when the policy loses and becomes expansionary? We have read that model, but now we are reading the transmission channel. So the first is the interest rate channel. The monetary policy decisions in the interest rate channel are always about nominal interest rate. When the state bank of Pakistan announces the policy rate, then it is a target but the interest rate for the target is nominal. But remember that the decision is nominal but in the mind of central bankers or central bankers there is a real interest rate. That is, they want to change the nominal interest rate and actually change the real interest rate. We will read it further. We had discussed in a lecture that if expectations are given and they are not adjusted in the short run, then the real interest rate will be changed whenever the nominal interest rate changes. This means that if the central bank changes, then the nominal interest rate changes but the objective of changing the real interest rate for an profit is to因 economy to affect real interest rate. This means that if the central bank changes the nominal interest rate and then the real interest rate changes then the cost of borrowing chain goes away. Why? Because the real cost of borrowing is determined by real interest rates. So, when that change occurs, then you know that if the borrowing cost changes, then the investment will change. And even the consumption of durable goods will change, which are financed on credit. That is, the credit that is taken. When the cost of borrowing changes on credit, then their demand will also change. So, this transmission channel is why the aggregate demand changes? Because of the cost of borrowing. And what does the cost of borrowing affect the aggregate demand? Does it affect the investment? Or does it affect the consumption of durable goods? This is a normal way of reading different books. When they want to tell you the transmission mechanism, then a diagram is shown like this. Or a schematic is shown like this, in which the arrow shows that the bridging variables come between the arrows and the idea is that the variable is increasing or the variable is decreasing. So, here we say that the suppose policy has to be tight in the central bank. So, what will it do? It will reduce the nominal interest rate. Sorry, if you want to do expansionary, then it will reduce the nominal interest rate. And if expectations are given of inflation, we will read this topic in detail. When expectations are given of inflation, then its effect is on the real interest rate. So, for the time being, you can start from here that the central bank effectively reduces the real interest rate in the nominal bank. So, you will see here in the diagram, you can see that the real interest rate is decreasing. So, if the real interest rate is decreasing, then the cost of borrowing increased. Sorry, the cost of borrowing decreased. The more the cost of borrowing decreased, the demand of the investment increased. So, the next arrow is the upward direction. And in that arrow, the investment is written. So, the investment increased. And since the investment is a component of aggregate demand, then the aggregate demand increased. Whereas, the second channel could be that when the real interest rate has decreased, which means the policy has become expansionary, then the consumption of durable goods has increased. And the consumption of aggregate demand has also increased. So, the aggregate demand has increased. So, through this channel, what is the variable change due to which variable? And what is the effect of the ultimate aggregate demand due to that? Here, this was the interest rate channel. The topic of interest rate channel is over. But there are some points related to that which are important in this lecture. One of them is that ultimately what matters is real interest rate. Not nominal. Decision central bank does take on nominal interest rate. But due to that, real interest rate changes. The real cost of borrowing changes due to which investment or consumption changes. Second point. Remember about interest rate that the short term interest rate tries to change the central bank. Or the focus of that is the short term interest rate. But the interest rate that affects the investment is long term. The short term interest rate will change the short term borrowing. So, the short term borrowing is not for investment. It is to fulfill the need for the RZ. One bank needs money today and the money tomorrow will be managed. So, its cash or liquidity is being shorted for one day. So, it will take the short term loan for one day. It has nothing to do with investment. Investment will affect the long term interest rate. So, two things have been clarified. Interest rate is not nominal but real which affects the economy. The short term is not the short term but the long term. The central bank decision takes on the short term. But the short term affects the long term. So, the investment decision changes. Remember this. It will be clear that the variable real which is actually necessary does not directly change the central bank. It changes nominal but changes real from nominal. And the actual interest rate that affects the investment is the long term. But the central bank decision takes on the short term. And because of the short term interest rate, the long term interest rate changes. So, let us see how this changes. Remember one thing. There is an interest rate theory which is term structure of interest rate. And term structure of interest rate has an expectation theory or expectations hypothesis. Which we say that the long term interest rate is the average of future expected short term interest rates. This means that when the central bank changes the short term interest rate, then how the long term interest rate changes? So, the central bank changes the short term interest rate and shows its commitment that the direction in which we changed the interest rate or increased the interest rate, then in the next few times we will keep it at a higher level. We have to control the inflation. So, if the central bank gives a signal that the current interest rate that we have increased, we will not bring it back down. This means that people's expectations will change about the short term interest rate of the future. And because the long term interest rate is the average of the expected future short term interest rates, then the long term interest rate increases. And the central bank has changed the short term interest rate, but the long term interest rate changes due to expectations. Similarly, when we talk about the real interest rate, then this also remains in your mind that the central bank changes the nominal interest rate. But if expectations are given, i.e. expectations are not revised with the policy of the one to one central bank, then the real interest rate changes because the definition of the real interest rate is nominal interest rate minus expected inflation rate. We will read this in more detail. Since the real interest rate comes from the nominal interest rate minus the inflation rate, i.e. when the central bank changes the nominal interest rate, then if expectations do not fully revise the inflation rate, then the real interest rate changes. So, the central bank changes the short term interest rate, because of that the long term interest rate changes, the central bank changes the nominal interest rate, because of that the real interest rate changes, and the real interest rate of the long term affects the investment and consumption, and because of that the aggregate demand changes. The last point in this channel is that when there is a time for your crisis, i.e. financial crisis, or any other type of economy, there is an extreme situation in which, for example, the interest rate has to reduce the central bank. For example, in Pakistan, in the situation of Covid, in that time period, the central bank reduced its interest rate and policy rate to 7%. It was reduced to 7%. Although after that it increased, even before that, in this type of situation, in the situation of crisis, the central banks reduce their interest rate. Now, when the interest rates are reduced, they are short term, then how long term interest rates change? So, remember that those expectations are proved. That if the central bank doesn't make people, economic agents, believe that we will increase the interest rate in the long term, and we will reduce the interest rate in the long term. So, people's expectations increase, that expansionary monetary policy, if it stays in the long term, then ultimately, the expected inflation rate will increase. i.e. their expectations are increased, that the inflation rate will increase in the future. And because their expected inflation rate is increasing, the nominal interest rate, even though the central bank doesn't even take the lower level, the real interest rate starts to decrease. And because of the real interest rate, the consumption and investment increases, and because of that, the aggregate demand increases, and the economic crisis recovers. Even if the nominal interest rate goes down to zero, then when you go there, you know that the interest rate cannot go down further, then how the aggregate demand can be affected? That is also through the real interest rate, that if the central bank shows its commitment, that in the short long run, we will keep the interest rate below, then people's expectations will increase, that in the long run, the inflation rate will increase, because of which the real interest rate will decrease, and ultimately, the aggregate demand increases. Thank you.