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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

Don't damend work in inflation
Mishael Reply
conceptand variable of macro economics
Bittu Reply
macro economics is the study of general factors in an economy.
what is fiscal policy?
fiscal policy refers to the use of government spending,taxation and borrowing to affect economic activity ,monetary policy on the other hand, entails the manipulation of interest rates.
A lots of thanks
you are welcome
Very informative talukder
yes Jafta
So scarcity will always be a problem, is something that can't be solved due to specialization of labor and choice?
yes right Jafta
good definition Jata♥♥
how are you all
Kindly explain or give example of Voluntary unemployment.
when unemployment doesn't choose a accept job at wage of rate
Thanks Talukder
macroeconomics is not too hard
wow Omar, ur so helpful lol🤣
good ho every one
what's up guys■■
I want someone to tell me everything about the inflation and and hyber inflation is plz
dot US Army higher South Korean citizen for the US base South Korea and pay them 50000 as a result
farzana Reply
What is production possibility frontier
adewale Reply
Production possibility frontier is a curve depicting all maximum output possibilities for two goods, given a set of inputs consisting of resources and other factors. The production possibility curve is frontir that all inputs are used efficiently.
what are some examples of a monetary policy?
Viccey Reply
expansionary policy contractionary policy
what is scarcity
van Reply
scarcity is like having so much of goods and services to access and you want them
how to calculate GDP
Gdp =c+I +nx +G
GDP=rent+interest+wages and salaries+profit
what are the assumptions of the marginal utility theory ?
GDPfc=GDI+stock dep-stock app+- residual errors
marginal cost and marginal benefits
Racheal Reply
what is unemployment
Nazer Reply
The total number of people in the labor force who are willing to work and actively looking for a job but cannot find one.
Heckchers Ohlin theory of International trade
Lal Reply
but if I may ask what brings this poverty in existence and how can such actions be deminish in our generation
Philemon Reply
Poverty comes from many factors, ranging from very low income for the households sector (purchasing power is low), basic needs such as safe drinking water, lack of sustainable development goals (roads, agriculture, technology, power, etc), business sector is poor, etc
Such action can be diminished by effectively and efficiently using the four (4) factors of production. Land, Labor , Capital and Technology.
Poverty - Increase in the cost of living without subsequent increase in the amount of minimum wage. Poverty can be reduced extremely if the minimum wage equals or equals more than the cost of living.
land labour capital and organisation factors of production
what are positive and normative statements
Alethia Reply
positive is realistic normative is imaginary
give basic idea about India's national income
Maloy Reply
what are the sources of recessions and booms
Zweli Reply
A few years ago, Ama paid $500 to put together a record collection. Today she sold her albums at a garage sale for $100. how does the same affect GDP?
teresa Reply
It saves time its creates more employment
Gold Reply
Scarcity means human wants exceeds the resources needed to satisfy them 1. Limited resources 2. Numerous human wants
Scarcity means shortage!!!
Gold you're knowlwgist bro keep going lion
hmm am fresh here oh
Being newest means u have it all!!!
where you from university of malakand.or where are you.
What is mean by small open economy ?

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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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