3.5 Monetary Policy

Monetary Policy

Use of interest rates and money supply to influence the level of AD

Interest Rate

Cost of borrowing or return of money to savers

Money Supply

Quantity of money circulating the economy

Limitations of Monetary Policy

1. Consumer/Business Confidence

   • If closing a recessionary gap, confidence of consumers and businesses are already low

   • Hence they may choose to not take up a loan and start spending

2. Zero Lower Bound

   • Interest rates cannot be below 0, therefore if existing interest rate is very low, policy may not be very effective

Advantages of Monetary Policy (IS)

1. Incremental and Flexible

   • Policymakers can adjust the rate incrementally, reducing risks/harm to economy

   • No political limitations

2. Short Time Lags

   • Can be implemented ASAP in comparison to fiscal