Question

What are the short-run and long-run effects of monetary tightening on nominal interest rate? 12. Ture of False (based on Question 11 above): In the short run, normal interest rate does not rise as much as the real interest rate. (Please justify)

Answer 1

Answer to question no. 11

Tight monetary policy is a policy implemented by the central bank to curb the rising inflation rate or to control over heated economic growth. It is also a measure to put a control on the expenditure to control the inflation rate in the economy.

Under this policy the central bank raisies the short term interest rates. Raising the short term interest rates also increases the cost of borrowing due to which people are less attracted towards the borrowing and their purchasing power decreases. A decrease in the purchasing power of the consumer curbs its expenditure and inflation rate decreases. Inflation rate or overheated economic growth can also be treated by Open Market Operations by the central bank. When central bank sells its assets in the market, liquidity in the market is reduced which controls the inflation rate and economic growth of any economy.

Answer to question no. 12

It is true to say that in the short run normal interest rate does not rise as much as the real interest rate.

Real interest rate is the interest rate which is adjusted by the central bank to control the rate of inflation. Referring to question no. 11, when central bank imposes a tight monetary policy it rises real interest rate to control the rate of inflation.