Question

What are two drawbacks to using monetary policy to stabilize the economy

Answer 1

The central bank is responsible for conducting the monetary policy inorder to manage money supply and interest rates in the economy.

monetary policy has various advantage like the inflation rate control by interest rate targetting, boosting up of exports, and quicker implementation etc.

But it has various drawbacks too. Two of the main drawbacks of monetary policy are:

1. Monetary policy can lead to hyperinflation:-

• When money supply increases, the inflation rate also increases.
• Fed increases money supply in the economy to increased aggregate demand and supply.
• But to create excess demand, when they increase the money supply further, the inflation rate goes up too rapidly.
• It becomes out of control and changes to hyperinflation.
• At this point, the monetary policy becomes ineffective in stabilizing the economy.

2. Time lag in monetary policy:-

• Monetary policy is said to longer time lags than the fiscal policy.
• This lag is due to the delay in acceleration and deceleration of money supply in the economy.
• Time lag in monetary policy ranges from few months to a period of about 2 years.
• Because of this lag monetary policy fails in bringing stability in the economy sooner.