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MONETARY POLICY, Aim: ensure stability in GPL, a :arrow_up: level of…
MONETARY POLICY
Limitations
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Business expectations
-economic outlook is +ve & incomes are expected to increase: firms expect DD for their products to grow=> higher profits in future
-expected future returns on I will :arrow_up: => rightward shift in MEI curve=> I will still :arrow_up: even if there is a rise in I rate =>contractionary monetary policy ineffective in restricting AD
-opp for -ve economic outlook and firms are pessimistic
Size of multiplier
-smaller size of multiplier: weaker effect on national income and econ growth, given a :small_red_triangle: in I and AD
=> monetary policy is less effective in such countries w small multiplier
Workings
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Expansionary MONETARY policy:
- :arrow_up: :heavy_dollar_sign: or :arrow_down: interest rates to :arrow_up: AD and hence, economic activity
Contractionary MONETARY policy:
- :arrow_down: money SS or :arrow_up: interest rates to :arrow_down: AD
-typically used to promote :heavy_dollar_sign: stability by controlling inflation
TARGETS
Interest rate policies
Problems
- :arrow_up: interest rates may not affect borrowing during times of oom when businesses & households are v optimistic
- :arrow_down: interest rates may not be effective during depression
-during :arrow_up: unemployment, :arrow_down: interest rates might not cause sig :arrow_up: in purchase borrowing in market for consumer goods
Advantages
- :small_red_triangle: interest rates can be used tgt w other measures + this policy is highly flexible & can be applied quickly
-during booms and slums: affects profitability of investments and willingness to spend
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Aim: ensure stability in GPL, a :arrow_up: level of employment & sustained economic growth
When economy is at liquidity trap (DD for :heavy_dollar_sign: is infinitely elastic), LP is horizontal & :arrow_up: in :heavy_dollar_sign: SS will not result in any :arrow_down: in interest rates