Question

Discuss the effect of monetary policy on investment spending.

Answer 1

Monetary policy is a strategic tool to control the flow of money. Through the monetary policy the government controls the amount of money circulating in the economy and to determine the worth of money that is interest rate. The main purpose of monetary policy is to achieve the long term economic goals.

Impact of monetary policy on investments

Consider a scenario when economy is growing rapidly then the inflationary rate too will be growing rapidly. Due to rapid economic growth the individuals will be earning a higher income thus, they will demand more of any commodity. As a result aggregate demand will be high thus inflation too will be high.

In this case the federal bank will raise the short term interest rate.

While in case of slow economy the central bank may reduce the short term interest rate in order to get the economy back on track.

Thus, it has direct impact on the interest rate which is one of the major factors that affect the investments. While indirect impact is through the inflation.

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