Question

Draw a graph to show why conventional monetary policy became ineffective during the Great Recession.

Answer 1

We know that conventional monetary policy uses to correct short term fluctuations in prices and output by using the short term interest rates. In US the interest rate is federal funds rate. The Federal Reserve targets short term interest rate. At the time of recession the fed lowers its funds rate. If the fed lowers the federal funds rate people will purchase more reserves through open market operations. At the time of great recession Federal Reserve fed reduces the interest rates. If the fed reduces the rates then banks can borrow easily from each other to meet their financial needs. When fed reduces the funds rate people can shop more, home loans becomes again cheaper and they go for more loans. This will again increase the problem of recession. To reduce federal funds rate it causes inflation. That is,

In the Graph the initial interest rate is r and initial quantity of money is Q. The fed reduces interest rate to r to r1, The money supply increases to Q to Q1. It increases the money supply in the economy creates inflationary pressure. The Main problem for great recession is Inflation. Fed reduces interest it will create again inflationary pressure in the economy. So the conventional monetary policy is ineefctive during the great depression.