Question

MONETARY POLICY

E Monetary Policy; F) Expansionary Monetary Policy;

G) Problems in the implementation of Monetary Policy

Answer 1

E.

This is government policy of controlling money supply in the economy. Required objective is to improve the market by controlling interest rates, purchasing or selling bonds, etc. Suppose the increasing interest rate decreases the money supply in the economy, or vice versa.

F.

This is the policy of government for increasing spending and/or decreasing interest rate to boost up the economy. GDP declines during the phase of recession. In order to boost up the economy, the expansionary monetary policy could be taken by the government. Under this policy the government spends more for economical development. More and more projects will develop, people get jobs, and earnings will increase. Such increase in output leads to increase in aggregate demand.

Government can decrease the interest rate so that people can take loan. At the same time government would go for selling bond. It is necessary, since the excess loan can’t increase inflation. Moreover, the sale proceeds could be utilized for development work and for improving the economy.

G.

Implementing this policy may have certain problems. These are as below:

No.1) There is no link between money supply and production or economic growth. Production depends on factors of production (land, labor, capital, and organization) but not depends on variables of money. Example: suppose money supply increases but there is a shortage of labor factor; in such case production can’t be improved but inflation rises.

No.2) If an increase in supply of money in an economy can’t decrease the rate of interest, then this is the liquidity trap. In this trap country’s monetary policy becomes ineffective. Example: It happens if an economy suffers of deep depression. In this situation the interest rate is already very low and the liquidity preference is elastic at a particular interest rate. Additional supply of money can’t reduce the interest rate further. Therefore, monetary policy is useless to rescue from deep depression or recession.