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By the end of this section, you will be able to:

  • Analyze whether monetary policy decisions should be made more democratically
  • Calculate the velocity of money
  • Evaluate the central bank’s influence on inflation, unemployment, asset bubbles, and leverage cycles
  • Calculate the effects of monetary stimulus

In the real world, effective monetary policy faces a number of significant hurdles. Monetary policy affects the economy only after a time lag that is typically long and of variable length. Remember, monetary policy involves a chain of events: the central bank    must perceive a situation in the economy, hold a meeting, and make a decision to react by tightening or loosening monetary policy. The change in monetary policy must percolate through the banking system, changing the quantity of loans and affecting interest rates. When interest rates change, businesses must change their investment levels and consumers must change their borrowing patterns when purchasing homes or cars. Then it takes time for these changes to filter through the rest of the economy.

As a result of this chain of events, monetary policy has little effect in the immediate future; instead, its primary effects are felt perhaps one to three years in the future. The reality of long and variable time lags does not mean that a central bank should refuse to make decisions. It does mean that central banks should be humble about taking action, because of the risk that their actions can create as much or more economic instability as they resolve.

Excess reserves

Banks are legally required to hold a minimum level of reserves, but no rule prohibits them from holding additional excess reserves    above the legally mandated limit. For example, during a recession banks may be hesitant to lend, because they fear that when the economy is contracting, a high proportion of loan applicants become less likely to repay their loans.

When many banks are choosing to hold excess reserves, expansionary monetary policy may not work well. This may occur because the banks are concerned about a deteriorating economy, while the central bank is trying to expand the money supply. If the banks prefer to hold excess reserves above the legally required level, the central bank cannot force individual banks to make loans. Similarly, sensible businesses and consumers may be reluctant to borrow substantial amounts of money in a recession    , because they recognize that firms’ sales and employees’ jobs are more insecure in a recession, and they do not want to face the need to make interest payments. The result is that during an especially deep recession, an expansionary monetary policy may have little effect on either the price level or the real GDP    .

Japan experienced this situation in the 1990s and early 2000s. Japan’s economy entered a period of very slow growth, dipping in and out of recession, in the early 1990s. By February 1999, the Bank of Japan had lowered the equivalent of its federal funds rate to 0%. It kept it there most of the time through 2003. Moreover, in the two years from March 2001 to March 2003, the Bank of Japan also expanded the money supply of the country by about 50%—an enormous increase. Even this highly expansionary monetary policy, however, had no substantial effect on stimulating aggregate demand. Japan’s economy continued to experience extremely slow growth into the mid-2000s.

Questions & Answers

an increase in demand (while supply remains constant) what will happen to deh graph?
Thabiso Reply
what is going to happen to the graph if there is an increase in demand, While supply remains constant .
Thabiso
What will happen to the graph if there is an increase in demand While supply remains constant?
Thabiso
price will increase high than automatically demand will decrease
takshaveer
equilibrium ?
Issum
is when the supply and demand are balanced
ISAH
what is demand
Sarkwah Reply
demand is the willingness to buy a commodity backed by the ability to pay.
Runwell
demand is mere desire on commodity with ability to back up with purchasing power
Terkimbi
Equilibrium is when there's an equality between quantity demanded and quantity supplied
Victory Reply
Again the consumer will be in equilibrium if the price of the commodity is equal to Marginal utility of that product
daniel
wat is the law of supply
Agnes Reply
It's what* -The law of supply states that price and supply is relative. As all factors are equal, if price increases then quantity of supply there for increases.
Nathaniel
the law of suppy state that when prise is high, more commodity with be supply and when p is low less of the same commodity will be supply.
BEGE
It states that, "other things being equal, move supplied at a higher price than at a lower price ".
Murewah
okay
Agnes
it's state that the increased in prices will lead to decreased in supply
Asuquo
what is the theory of supply and the determinants of demand
Murewah
And please what is change in quantity supplied?
Agnes
guys why are you so quiet
Murewah
A woman has a television set which cost her $800 two years ago. A new set would cost her $1000 and she could sell her television set for $450. What is the opportunity Cost of keeping the old TV?
Murewah Reply
principle of effective demand?
Abubakar Reply
the is the situation in which the need of individuals exceed the available resource. increase in population rate and wrong decision making
esther Reply
what is the different between wants and demand?
Terkimbi
wants are what people desire to have but they can live without them and demand is a thing that is most wanted
Murewah
what are the demand pull inflation
Hijja
the higher the aggregate level of activity, the larger the proportion of areas and industries which experience excess demand for goods and labour of various sorts , and the more powerful is demand-inflationary pressure . Demand inflation is contrasted with cost inflation , in which price and wage
Murewah
increases are transmitted from one sector to another. These should be regarded as different aspects of an overal inflation starts , cost inflation explains why inflation once begun is so difficult to stop.
Murewah
what is the important difference between positive and normative economics
Umar
positive economics is the study of how an economy works in practice, as opposed to the theoretical study of how it should run in theory and normative economics is the party of economics that is concerned with how the economy ought to be run.
Murewah
positive economic deal with fact and also talks about how the economy actually is like while normative economic deal with value judgement and talks about how the economy ought to be like
esther
What is the difference between opportunity cost and choice
Murewah
opportunity cost are also known as forgun alternative why choice is to select one among alternative
Terkimbi
importance of economic
Zakaria Reply
satisfaction of human wants
Festo
economics is about to economise . discuss
Angel Reply
Underlines the efficiency aspect. Economise towards what: Economise factors to reach equal distribution of Material wealth or Just to operate optimally to Service demand, i. e. Run markets efficiently?
Homo
join the conversation
abba Reply
Hi I'm Ashnly Parker.
Murewah
what is terms of trade
Ibrahim Reply
different btn import and export
Angel
No question... This is nice
Gbenga Reply
hw can we solve problem of scarcity
Oigebe
scarcity is not necessarily a problem but a constant condition of the world. there are not enough resources to satisfy the unlimited wants.
Matthew
wee need to be cooperative
Zakaria
by unlimited resourses and abundant want
Angel
What is the economic problem
Murewah
inflation
Lazizjon
And what is demand pull inflation
Murewah
why do compute GDP?
steven Reply
can anyone shortly determine the word inflation.
Ibrahim Reply
Continous increase in the general level of prices or in the cost of living.
arshad
persistent increased in general price level
Machall
all correct...
paa
inflaction
Angel
rise in price.
Abubakar
deserving of money
Lazizjon
A persistent tendency for nominal prices to increase
Murewah
What is the problem of economic problem
Murewah
the father of economics
Reuben Reply
Adem smith
sj
Adem smith
Ajit
Adem smith sure
Adigwe
the father of economic regarding to adam Smith
Ibrahim
the father of political of economic and capitalism in his book and inquary in to the wealth of the nation.
Umar
Adam Smith his the father of economic
Mamudu
difference between injection and leakage
Asif
what is monopoly
Razak
Monopoly is a market structure where there is one firm who dominate the industry
wisdom
hi,, I am new here. please welcome me.
Mohammad
you are welcome
Adigwe
monopoly is the one characterized by a mkt power in which a firm is a price maker
Festo
Some member just ask questions but not answering so y this happen
Festo
Monopoly is a market where only one seller exists. No competition
Fred
how long does the patent right prevail the monopoly
Festo
no attempt
Zakaria
what is state farming
Sadiq
anybody to attempt
Festo
Hi, I'm a new member please will you welcome me
Murewah

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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