Question

3. In a speech in January 1995, Speech by Alan Greenspan before the Board of Directors of the National Association of Home Builders, January 28, 1995. Federal Reserve Chairman Alan Greenspan used a transportation metaphor to describe some of the difficulties of implementing monetary policy. He referred to the criticism levied against the Fed for shifting in 1994 to an anti?inflation, contractionary policy when the inflation rate was still quite low: “To successfully navigate a bend in the river, the barge must begin the turn well before the bend is reached. Even so, currents are always changing and even an experienced crew cannot foresee all the events that might occur as the river is being navigated. A year ago, the Fed began its turn (a shift toward an expansionary monetary policy), and it was successful.” Mr. Greenspan was referring, of course, to the problem of lags. What kind of lag do you think he had in mind? What do you suppose the reference to changing currents means? To the Tutor: Please be clear and explanatory. Will be appreciated. Thank you.

Answer 1

Any monetary policy implemented requires time to act and bring changes in the economy , this mainly occurs due to sticky prices . Suppose an expansionay monetary policy has been implemented , which increases money supply in the economy to boost the economy . But this increase in money supply generated due to tax cuts and keeping interest rate low may have some lags . As for example the aggregate demand may not rise quickly in the economy due to tax cuts . People might respond initially by saving more or changing consumption pattern may require some time . On the other hand loweing of interest rate may not induce investors to invest more all of a sudden . it takes time for the economy to adjust , prices to rise and to steer the economy our of recessionay trends . This is the lag mentioned above . Also corruption , no direct linkage between lowering interest rate and increase in output are other lags .

Here changing currents refers to changing economic conditions . Economic conditions not only change due to monetary and fiscal policy but also due to various other reasons such as natural calamities , foreign investment , international trade , infulx of labour , expectations of consumers and producers etc . So the currents or ecenomic variables such as price , aggregate demand etc are always changing .