Question

MISKIN

Why have conventional monetary policies become ineffective?

Answer 1

It has been observed that during the times of deep recession in the economy, conventional monetary policies become ineffective. It is because their usefulness becomes limited during the time of recession in the economy. In the money market, when interest rates are reduced during the time of recession by increasing money supply to prevent the rate of interest frm falling too low, nominal interest rates are bound by zero and cannot fall below the zero level of interest and the economy is in the liquidity trap when rate of interest are low. When the economy is in the liquidity trap, then increase in the level of money supplied has no impact on the rate of interest which are already very low and conventional monetray policy becomes ineffective in this case.

Another reason of conventional monetary policies becoming ineffective is that bank reserve requirements cannot be made so low that those banks default and there is economic crisis deepening in the economy.

Here , comes