Measures to reduce cyclical unNt: EMP

Question 1

Define expansionary monetary policy (EMP)

Answer 1

• designed to affect AD by changing short-term interest rates
• suitable if cause of unNt is due to fall in C and I which reduces AD (cyclical unNt)

Question 2

How does EMP work?

Answer 2

• when central bank utilises expansionary policy, can:
  1. increase money supply
  2. relax control on bank lending
• rise in money supply results in fall in i/r, causes cost of borrowing to fall
• stimulate C and I, AD rise
• e.g. central bank of US printed more money, injected into commercial banking system, made credit easier to obtain with bigger money supply and lowered i/r (COVID-19) (to aid falling economy)
• rise in AD causes shortage of goods and services, incentive for firms to increase production, increase in national output, NY and employment, reducing cyclical unNt

Question 3

Strength of EMP

Answer 3

1. Relatively quick implementation
2. Central Bank independence
3. Ability to adjust i/r incrementally (small steps)

Question 4

Constraints of EMP

Answer 4

1. Limited scope of reducing i/r that are close to 0
2. Responsiveness of firms and households to fall in i/r \
3. Conflict with other macroeconomic goal
4. Time lag

Question 5

Relatively quick implementation (+)

Answer 5

• implemented faster than EFP

- doesn’t need to go thru political process (cumbersome, time-consuming)

Question 6

Central Bank independence (+)

Answer 6

• independence from gov
• can make pragmatic decisions best in longer term interests of economy
• greater freedom in implementing politically unpopular policies

Question 7

Ability to adjust i/r incrementally (+)

Answer 7

• i/r can be increased gradually
• btr suited to ‘fine tuning’ economy as compared to fiscal
• still subjected to limitation, no policy tool that can fully ‘fine tune’ economy

Question 8

Limited scope of reducing i/r that are close to 0 (-)

Answer 8

• less effective as increase in money supply doesn’t lower i/r by much
• may not bring much positive impact on I and C

Question 9

Responsiveness of firms and households to fall in i/r (-)

Answer 9

• recession, business and consumers ‘ confidence low
  , may not be responsive
• any fall in i/r, only small rise in I or C ceteris paribus
• rise in AD not significant
• not effective in stimulating investment, consumption and reducing unNt

Question 10

Conflict with other macroeconomic goal (-)

Answer 10

• using EMP to promote growth may lead to conflict with macroeconomic goal of low inflation
• rise in AD leads to rise in GPL when economy is near full employment

Question 11

Time lag (-)

Answer 11

• time lag between changing i/r and change if C&I taking effect (response lag)
• some economists estimate that it takes 18 months for i/r changes to impact economy
• economy might have turned arnd when original cause of problem has weakened (unNt)
• full impact of delayed EMP might lead toa new problem, inflation (not unNt anymore)
• economy might have worsened
• initial EMP policy not effective, larger increase in money supply required for greater fall in i/r, AD rise to reduce unNt

Question 12

Conclusion

Answer 12

• Export dependent countries ie. SG
• cyclical unNt mainly due to fall in external demand
• rise in G not effective
• need to widen export markets
• e.g. SG trading partners include emerging economies ie. Brazil, Russia, India, China (BRIC), Middle Eat
• reduce reliance on traditional trading partners e.g. US, Japan, Europe