Question

What are the factors that affect the effectiveness of monetary and fiscal policy?

Answer 1

The factor which causes monetary policy ineffectiveness occurs in the third stage of the transmission mechanism, namely changes in aggregate spending or demand in response to interest rate changes. This happens when interest rate changes have negligible effects on planned autonomous spending, especially investment spending. This condition arises when business companies are so pessimistic about potential prospects of profit making that they are reluctant to pursue any more investment in response to lower interest rates. As a result, an rise in money supply that induces lower interest rates does not contribute to an increase in real national revenue.

Poor loans relating to real estate, i.e. homes, had been made in US banks. Instead of lending for private consumption and investment, banks bought government securities such as treasury bills that are very secure for banks to invest in. If banks do not lend for private investment because of risk aversion, the link in the transmission mechanism which involves more private investment in response to lower interest rates breaks down to boost real national income.

In this context, it is worth noting the strategy of 'quantitative easing' (QE) which the US Federal Reserve pursues under the leadership of its chairman, Ben Bernanke, to revive the American economy. Since 2010 the Federal Reserve has continually bought government securities under the program of quantitative easing and has been pouring more money into the American economy, that is, the US dollars, on a wide scale holding zero interest rates.

Central bank is separate from political interference. Full independence of policies is important.
Clarity of policy for the central bank. Must concern simply the maintenance / management of the currency's purchasing power compatible with labor market equilibrium, with the government's ban on direct monetary financing. Performance and honesty of people in central bank making monetary policy decisions.
If the currency exchange rate is determined by free-market powers, monetary policy's flexibility and effectiveness is less limited than when the authorities are attempting to control the exchange rate at a fixed level.

The less circulating physical money (notes and coins) and the more non-physical money (electronic money in bank accounts), the freer the central bank would be to establish negative nominal interest rates whenever necessary to prevent any danger of deflation during recession / depression.
In a broad "closed" economy (in terms of trade and capital flows), monetary policy appears to be less affected by foreign policy and circumstances in the rest of the world than would be the case in a small "open" economy with monetary policy.