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    Unit 12

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    Monetary policy aims to stimulate economic growth during recessions through lowering interest rates. However, it faces weaknesses including investors being reluctant to borrow in deep recessions and time lags before policy changes impact the economy. Central banks targeting inflation can combat inflation without political constraints but may be ineffective against cost-push inflation. Monetary policy also impacts exchange rates, creating conflicts between goals like growth and inflation.

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    Unit 12

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    2K views9 pages
    Monetary policy aims to stimulate economic growth during recessions through lowering interest rates. However, it faces weaknesses including investors being reluctant to borrow in deep recessions and time lags before policy changes impact the economy. Central banks targeting inflation can combat inflation without political constraints but may be ineffective against cost-push inflation. Monetary policy also impacts exchange rates, creating conflicts between goals like growth and inflation.

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    Monetary policy aims to stimulate economic growth during recessions through lowering interest rates. However, it faces weaknesses including investors being reluctant to borrow in deep recessions and time lags before policy changes impact the economy. Central banks targeting inflation can combat inflation without political constraints but may be ineffective against cost-push inflation. Monetary policy also impacts exchange rates, creating conflicts between goals like growth and inflation.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    2K views9 pages

    Unit 12

    Uploaded by

    api-260512563
    Monetary policy aims to stimulate economic growth during recessions through lowering interest rates. However, it faces weaknesses including investors being reluctant to borrow in deep recessions and time lags before policy changes impact the economy. Central banks targeting inflation can combat inflation without political constraints but may be ineffective against cost-push inflation. Monetary policy also impacts exchange rates, creating conflicts between goals like growth and inflation.

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    of 9

    Monetary Policy Evaluation

    Unit 12.1 - Lesson 3


    Learning outcomes:
    ● Evaluate the effectiveness of monetary policy through consideration of factors
    including the independence of the central bank, the ability to adjust interest
    rates incrementally, ability to implement changes in interest rates relatively
    quickly, time lags, limited effectiveness in increasing aggregate demand if the
    economy is in a deep recession and conflict among other macroeconomic
    objectives.
    ● Explain that central banks of certain countries, rather than focusing on
    maintenance of both full employment and low rate of inflation, are guided in
    their monetary policy objective to inflation target.
    Stimulating Growth During Recession - STRENGTHS
    Speed: No Politics:

    ● Implemented as soon as problem is ● Central Banks are independent of


    identified the government therefore decisions
    are not influenced by political
    Control: motives.
    ● Ability to adjust the money supply No Crowding-out:
    more discretely and finely than fiscal ● Fiscal Policy requiring government
    policy. borrowing drives up interest rates
    ● Monetary Policy is more finely and argued crowds out economic
    calibrated to address the problem at growth.
    hand. ● Monetary Policy by lowering interest
    rates avoids this.
    Stimulating Growth During Recession - WEAKNESSES
    Investors Reluctant to Borrow

    ● Deep recessions - consumer and investor confidence is low.


    ● Fearful of losing jobs cut back on large purchases, saving for “rainy day”.
    ● Firms aware of this decrease in consumer confidence
    ○ Reduce output
    ○ Reduces demand for new investment funds
    ● Thus reducing interest rates do not stimulate increases in AD

    Example Japan’s “lost decade” from 1991 to 2010

    Time Lags

    ● While quick to implement it takes time to impact the economy.


    Stimulating Growth During Recession - WEAKNESSES
    Changes in Elasticity of Demand for Investment

    ● Expansionary Monetary Policy results in a decrease in interest rate.


    ○ If economy is near full employment - demand for money is relatively elastic.
    ■ Businesses are willing to take advantage of the lower cost of borrowing.
    ■ Therefore the quantity demanded of money will be greater.
    ○ If economy is in a typical or deep recession - demand for money is relatively
    inelastic.
    ■ Businesses are not as willing to take advantage of lower cost of
    borrowing.
    ■ Therefore the quantity demanded of money will be less - resulting in a
    smaller increase in investment spending.
    Inflation Targeting - Strengths
    ● Politicians are reluctant to implement Contractionary Fiscal Policy to combat
    inflation for fear of losing votes.
    ● Central Banks can take direct action to control inflation without political constraint.
    ● Monitor CPI, PPI GDP Deflator and many more to assess inflation risk.
    ● Ability to increase or decrease interest rates incrementally to ensure they match
    price increases.
    ● Able to enact policies that are deemed by voters as bad though are necessary.
    Removes political implications from voters.
    ○ Fed Reserve under Paul Volker in 1979 pushed IR to nearly 20% attempting
    to dampen high inflation of the late 1970’s.
    ○ Recession that resulted was long - high unemployment & political turmoil.
    ○ Successful in reducing inflation - 30 years of IR around or below 5%
    Inflation Targeting - Weaknesses
    Time lags during high inflation

    ● Though it can be enacted quickly it can take several months of high interest for
    investors and consumers to change consumption and investment behavior.

    Ineffective against Cost-Push Inflation

    ● Effective to reduce demand-pull inflation


    ● Relatively powerless in tackling cost-push inflation
    ○ Increase IR may decrease price levels
    ■ Possibly deepen a recession - decreasing RGDP & increasing
    unemployment
    ○ Decrease IR - increase AD
    ■ Would not harm RGDP, but may lead to inflationary spiral
    Exchange Rate Management
    When a country raises or lowers it IR, it signals depositors and investors that banks
    are paying different rates of interest.

    Higher Interest Rates Lower Interest Rates


    ● Attract foreign depositers and ● Opposite occurs
    investors ● Capital outflows decreases the
    ● Foreigners must exchange or buy the Demand for the currency
    local currency. ● Drives down the value of the
    ● This capital inflow increases the currency - Depreciates the
    Demand for the currency currency
    ● Drives up the value of the currency -
    Appreciates the currency
    Conflicting Goals
    Increased Inflation
    Expansionary
    Monetary Policy growth, lower But
    unemployment Lower Exchange Rate
    = expensive imports

    Reduced growth,
    increased
    Contractionary Reduced unemployment
    Monetary Policy Inflation But

    Higher exchange rate =


    reduction in exports

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