Monetary Policy

Question 1

State the monetary policies.

Answer 1

• Expansionary Monetary Policy (EMP)
• Contractionary Monetary Policy (CMP)

Question 2

What components of AD does MP target?

Answer 2

C & I.

Question 3

How does EMP work?

Answer 3

EMP lowers i/r or increase money supply to increase AD.

Question 4

What macroeconomic problems do EMP solve?

Answer 4

When the economy experiences -ve EG and high unN during a recession.

Question 5

How does EMP (lowering i/r) affect AD?

Answer 5

HH: EMP → lower i/r → decrease COB → HH incentivised to buy big ticket items such as cars, properties through loans → increase autonomous C → increase AD

HH: EMP → lower i/r → decrease returns on savings → encourage HH to save less, spend more (lower opp. cost on C) → increase autonomous C → increase AD

Firms: EMP → lower i/r → decrease COB → assuming constant EROR, MB (EROR) > MC (i/r) → firms invest more → increase I exp. → increase AD

Increasing money supply also leads to lower i/r.

Question 6

How does EMP (lowering i/r) boost EG and reduce unN?

Answer 6

Increase in C & I → increase in AD
assuming economy operating below Yf → unplanned fall in inventories → firms increase production by hiring more FOP such as labour → HH receive more factor income → increase PP, increase induced C → further increase in AD, multiplied increase in RNY → increase EG, decrease DD-unN

Question 7

How to implement CMP?

Answer 7

CMP increases i/r or reduces money supply to decrease AD.

Question 8

What macroeconomic problems do CMP solve?

Answer 8

High inflationary pressures.

Question 9

How does CMP impact AD?

Answer 9

HH: CMP → higher i/r → increase COB → HH discouraged to buy big ticket items such as cars, properties through loans → decrease autonomous C → decrease AD

HH: CMP → higher i/r → increase returns on savings → encourage HH to save more, spend less (higher opp. cost on C) → decrease autonomous C → decrease AD

Firms: CMP → higher i/r → increase COB → assuming constant EROR, MB (EROR) < MC (i/r) → firms invest less → decrease I exp. → decrease AD

Reducing money supply also leads to higher i/r.

Question 10

How does CMP tackle inflation?

Answer 10

decrease in C & I → decrease AD → decrease GPL

assume economy near full employment → unplanned rise in inventories → firms decrease production by cutting back on FOP such as labour → jobs are lost, increase unN → more efficient factor combinations → decrease UCOP → GPL decreases, less inflationary pressure

Question 11

How does CMP impact BOT?

This is not the main intention of CMP as CMP also leads to reduced SOL.

Answer 11

AD: CMP → higher i/r → increase COB → HH discouraged to buy big ticket items such as cars, properties through loans → decrease autonomous C → decrease AD → fall in RNY → decrease induced C of g&s including imports → DD for imports decreases → M decreases → (X-M) increases → BOT improves

Question 12

State the points of evaluation of monetary policy.

Answer 12

• Interest rate sensitivity of C & I exp. (impt!)
• Size of multiplier.
• Size of domestic sector.
• Liquidity trap.
• Type of ex/r system.

Question 13

Explain the evaluation made with i/r sensitivity of C & I exp in MP.

Question 14

Explain the evaluation made with size of multiplier in MP.

Answer 14

How significant the increase in RNY would depend on size of multiplier which is dependent on MPW (MPS + MPT + MPM)

The smaller the MPW (or larger the MPCd), the larger the multiplier size will be, MP will be more significant in boosting EG using EMP

Only applicable to EMP (boosts EG)

Question 15

Explain the evaluation made with size of domestic sector in MP.

Answer 15

• Size of domestic C & I as a % of GDP matters
• If size of domestic C and I is small, increase in AD when i/r decrease will not be significant, less effective policy
• i/r-centred monetary policy is more effective in economies where size of domestic sector is large.

Applicable to both EMP (during recession) & CMP (DD-pull inflation).

Question 16

Explain the evaluation made with liquidity trap in MP.

Question 17

Explain the evaluation made with the type of ex/r in MP.

Question 18

Explain quantitative easing.

Question 19

What is ex/r-centred MP?

Answer 19

Foreign ex/r policy is a policy centred on the management of the ex/r.

Question 20

What components of AD does ex/r-centred MP target?

Answer 20

(X-M).

Question 21

Which central banks have the option of conducting ex/r-centred MP?

Answer 21

ex/r-centred MP is possible in economies where a managed float ex/r system has been adopted.

CBs that wish to target ex/r cannot have independent i/r policies.

Question 22

How does ex/r-centred MP (by weakening currency) impact BOT?

Answer 22

CB sells more SGD for foreign currency → weakening currency
Exports cheaper in foreign currency → DD for exports increase, X increase
Imports more expensive in local currency → Qd of imports decrease as consumers switch to domestically produced g&s → M decrease if |PEDm|>1
(X-M) increase → BOT improves, reduces trade deficit

Question 23

How does ex/r-centred MP (by weakening currency) impact EG?

Answer 23

CB sells more SGD for foreign currency (acts as a local) → SS of ex/r increase → depreciate → weakening currency
Exports cheaper in foreign currency → DD for exports increase, X increase
Imports more expensive in local currency → Qd of imports decrease as consumers switch to domestically produced g&s → M decrease if |PEDm|>1
(X-M) increase → AD increase → RNY increases by multiple folds via multiplier effect → boosts EG

Question 24

How does ex/r-centred MP impact unN?

Answer 24

CB sells more SGD for foreign currency → weakening currency
Exports cheaper in foreign currency → DD for exports increase, X increase
Imports more expensive in local currency → Qd of imports decrease as consumers switch to domestically produced g&s → M decrease if |PEDm|>1
(X-M) increase → AD increase → AD, RNY increases by multiple folds via multiplier effect → firms increase output by hiring more FOP such as labour → decrease DD-unN

Question 25

How does ex/r-centred MP impact DD-pull inflation?

Answer 25

CB buys more SGD using foreign currency (acts as a foreigner) → DD of ex/r increase → appreciate → strengthening currency
Exports more expensive in foreign currency → DD for exports decrease, X decrease
Imports cheaper in local currency → Qd of imports increase as consumers switch to foreign produced g&s → M increase if |PEDm|>1
(X-M) decrease → AD decrease → assuming economy operating near Yf → decrease GPLCB sells more SGD for foreign currency → SS of ex/r increase → depreciate → weakening currency
Exports cheaper in foreign currency → DD for exports increase, X increase
Imports more expensive in local currency → Qd of imports decrease as consumers switch to domestically produced g&s → M decrease if |PEDm|>1
(X-M) increase → AD increase → firms reduce production, cut back on FOPs such as labour → UCOP decrease → GPL decrease → decrease in DD-pull inflationary pressure

Question 26

How does ex/r-centred MP impact cost-push inflation?

Answer 26

CB buys more SGD using foreign currency (acts as a foreigner) → DD of ex/r increase → appreciate → strengthening currency
Exports more expensive in foreign currency → DD for exports decrease, X decrease
Imports cheaper in local currency → Qd of imports increase as consumers switch to foreign produced g&s → M increase if |PEDm|>1
imported inputs cheaper in local currency → decrease UCOP → increase AS → decrease GPL → decrease cost-push inflation due to imported inflation

Question 27

State the points of evaluation for ex/r-centred MP.

Answer 27

• PED for imports and exports
• Presence of spare capacity in economy
• Nature of economy
• Causes and mix of macroeconomic problems
• Retaliation by other countries
• Capital flight

Question 28

Explain the evaluation made with PED of imports and exports in ex/r-centred MP.

Question 29

Explain the evaluation made with presence of spare capacity in ex/r-centred MP.