Question

What is a good indicator of increasing mismatch between cash flows and cash commitments resulting from unmet liquidity constraints in an economy? A) A rise in the short-term money market rate of interest B) A rise in the long-term interest rate on government securities C) A fall in the short-term money market rate of interest D) A fall in the long-term interest rate on government securities

Answer 1

Mismatch between

1. Actual cash flows

2. Cash commitments resulting from unmet liquidity constraints

Unmet liquidity constraints, means that the required liquidity is not met.

The above mismatch means that there was some problem with the actual cash flows. Something happened which was not planned. Something happened which was unpredictable.

Given that, this mismatch is increasing, i.e. actual cash flows are increasingly different from the required cash flows.

Unmet liquidity constraints, means that actual cash flows are lesser than required cash flows.

Now, in this scenario, monetary policy should be expansionary, to meet the unmet liquidity constraints.

So, as part of expansionary monetary policy, Option C looks good here.

Option C is suggesting a fall in short-term money market rate of interest. This fall is expected to increase cash flow.

So the unmet liquidity constraints will now be met using this increase in cash flow (liquidity).