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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

what is gdp per capital and why it is used for?
Era Reply
gross domestic product
prince
gdp per capita is the gross domestic product per person (GDP/population) and is a better indicator of economic health and living standards than GDP alone.
Gina
thank you so much 😘
Era
please explain shift in production possibility curve
Kobby
advances in technology can cause a shift in the ppf because output can increase with use of the same amount of resources (laborers can produce more efficiently, and suppliers are willing to sell more)
Gina
what is crowding out effect?
Sera Reply
What is SAT AND GPA
prince
What to read the introduction
prince Reply
Keynesian theory of employment
sainlangki Reply
it's about use of Fiscal policy.
yvonne
yar what actually means of APc. averge means?. can someone give a best example plz
Asrar Reply
APC is average propensity to consume n this refers to ratio of consumption expenditure to corresponding level of income
Vishakha
then it means both MPC and ApC are same ?
Asrar
No..... APC is average propensity to consume whereas MPC is marginal propensity to consume
Vishakha
APC=C/I , MPC=∆C/∆I
Vishakha
which model predicted a global collapse in the world's social and economic system before the year 2010
Francis Reply
trade deficit
Amadou
is trade deficit the correct answer?
Abinash
yes
Amadou
what is the formula of mixed income ?
Sanjum Reply
NDPfc = COE + OS +MI MI=NDPfc- COE- OS
Vishakha
labor force in.Nigeria is seen as .......?
Aisha Reply
Is demand the same as being in need of a product?
Aphiwe Reply
yeah
Demand is defer from only need of products
Zubairu
need is the primary and main root of demand. but demand is the result of combination of need; income capacity and desire to expend of money for that product.
Ramu
products or services
jax
what is price determination?
Alick Reply
why are imports subtructed when GDP is calculated in the expenditure approach
nati
what is fiscalpolicy
nati Reply
The way of the government expenses and other analysis
Zubairu
It explains government spending and how it helps to direct the economy towards the desired direction. For instance, if the govt of a nation is desirous of achieving economic growth and development, then the govt will adopt an expansionary fiscal policy which imply more spending by the govt.
Sunday
and politics party important
mujtaba Reply
politics party important
mujtaba
Which party is that
Zubairu
persons who stopped searching for jobs but would accept if the opportunity presents itself
Torissa Reply
persons who are unemployed whether they are underage, retired or incapacitated
Torissa
the us economy is best characterized as?
Shekeriah
what is the impact of fiscal policy in the short and long run in the AD/AS model...
Hydrammeh Reply
What is demand
Mohd Reply
Demand is the desire for a commodity backed by the willingness and the purchasing power too.
Ajay

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Source:  OpenStax, Macroeconomics. OpenStax CNX. Jun 16, 2014 Download for free at http://legacy.cnx.org/content/col11626/1.10
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