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Chapter 8: Monetary Policy (Determination of interest rates (Business &…
Chapter 8: Monetary Policy
Determination of interest rates
Business & consumer expectations
Economic Growth
Changes in government expenditure
Expectation of changes in exchange rate
Openness of economy
Targets of monetary policy
Control Money Supply
Interest rate policies
Problem:
in times of boom when businesses ad households are very optimistic, high iterest rates may not deter borrowing
Advantages:
changes in interest rate can be used in conjunction with other measures and policy has the advantage that it is a flexible instrument which can be applied fairly quickly.
changes in interest rates can also have important psychological effect on business people expectations
Workings of Monetary Policy
Direct transmission mechanism: Given exceess liquidity, households and firms spend more on goods and services
Indirect transmission mechanism
Quantitative easing (useful when country is in liquidity trap): Deliberate attempt by central bank to increase money supply by buying large quantities of securities through open market operations.
Limitations of Monetary policy
Interest-elasticity of demand for money (Liquidity Preference)
Interest-elasticity of MEI
Business Expectations
Size of multiplier
Monetary Policy in SG
Small economy
Openness to trade flows
Small multiplier
Openness to capital flows