Question

1) Why is it possible to change real economic factors in the short run simply by printing and distributing more money?

2) Explain why a stable 5% inflation rate can be preferable to one that averages 4% but varies between 1-7% regularly.

3) Explain the difference between active and passive monetary policy.

Answer 1

1) Why is it possible to change real economic factors in the short run simply by printing and distributing more money?

Expansionary monetary policy involves the tools used to increase money supply, lowers interest rates in order to stimulate economic growth. In the short run, when the central bank prints and distributes more money, banks would have a high supply of loanable funds and this lowers interest rates. As a result, there would be an increase in the demand of loanable funds due to which businesses would expand which would lead to in an increase in real GDP. This would lead to more employment opportunities which would also increase the consumption power of the people.

2)Explain why a stable 5% inflation rate can be preferable to one that averages 4% but varies between 1–7% regularly.

For businesses to flourish and the economy to grow further, it is important that inflation rates remain stable. When the inflation rate is fluctuating, it is difficult for businesses to function properly as prices change frequently. As a result, investors would not get proper price values due to the uncertainty of the economy. This would lead to less investments in businesses which would then result in low economic growth. Thus, it would be much beneficial if the inflation rate is stable at 5% as businesses would be used to that rate rather than a fluctuating rate between 1-7%.

3)Explain the difference between active and passive monetary policy.

Active monetary policy is when the central bank uses monetary policies to reach certain macroeconomic goals such as economic growth, unemployment level, inflation, money supply. The cental bank chooses when to act and when not to depending on the situation of the economy. Therefore, under this a stable price level is maintained.

Passive monetary policy occurs when central banks only focus on money and price level while avoiding inflation effects. Therefore, passive monetary policy allows the economy to correct itself. For instance, interest rates would decline in a weak economy because demand for loanable funds would decline as the growth of the economy weakens. Therefore interest rates would decline and inflation would not increase much as well. Due to this, business investments would increase which would lead to a better economy. The major drawback is that passive monetary policy can take years to correct itself.

Hence, it is essential that the central banks takes control of the economy rather than waiting for the economy to improve on its own.