Question

Due to Covid -19 pandemic, government of Indonesia implements an expansionary monetary policy such as give stimulus to Small Medium Entreprise, lowering interest rate and decreasing reserve ratio. Indicate the impact of this policy on each of the following four variables:

-) inflation rate,

-) real output and employment,

-) real interest rate,

-) budget deficit.

Answer 1

Because of expansionary monetary policy, the lower interest rates and decrease in reserve ratio, the money supply in the economy increases leading to higher inflation rate. Increase in the money results in more spending by the consumers leading to higher inflation rate.

Because of higher supply of the money, the interest rates falls which results in more consumption by the customers and investments by the companies. Moreover, companies get low interest rate for raising the money. Therefore the real output increases and more investments leads to higher employment.

Beacuse of higher inflation rates, the real interest rates falls. Banks will start raising the interest rates to control the inflation. Due to higher inflation rate, the real interest rate falls.

Beacuse of expansionary monetary policy, government has to spend more. To spend more they have to raise the money more leading to budget deficit.