Tutorial sheet 4 Flashcards
(7 cards)
. Why do people demand money? What lowers the demand for money?
People demand money for transactions, precautionary reasons, and speculative motives.
What lowers money demand: Lower interest rates, more accessible alternatives like digital payments, higher income, improved economic stability, and deflationary expectations all make people less reliant on holding money.
What are the instruments used for conducting monetary policy? Produce a summary table of how each instrument can bring about the desired effects of monetary policy
Open Market Operations (OMO) Buying/selling government securities-Buying → Increases money supply, lowers interest rates, boosts economy.
Selling → Decreases money supply, raises interest rates, controls inflation
Reserve Requirements Central bank sets minimum reserves for banks Lower requirements → Banks lend more, increase money supply.
Higher requirements → Banks lend less, decrease money supply.
Interest Rates: Central banks set a lending minimum rate, also known as the discount rate. This is the interest rate at which commercial banks can borrow directly from the central bank. If the central bank increases this rate, borrowing becomes more expensive for banks, which reduces their lending to businesses and consumers. If the rate is lowered, borrowing becomes cheaper, encouraging more lending and spending.
What is your understanding of the term “the transmission mechanism”
The transmission mechanism is the process through which monetary policy decisions affect the economy. Interest rates and credit conditions are key channels, influencing consumer behavior, business investment, inflation, and employment. It helps central banks manage things like inflation and unemployment by influencing how much money is circulating in the economy.
What could cause a negative supply shock to an economy? What is the result of a onceand-for-all (isolated) negative supply shock that is not accommodated?
A negative supply shock can be caused by things like natural disasters, oil price hikes, labor shortages, supply chain disruptions, or new regulations. If such a shock is isolated and not addressed (like through monetary or fiscal policy), it results in higher prices, lower output, and higher unemployment, leading to an economic slowdown or even stagflation.
What is the result of a once-and-for-all negative supply shock that is accommodated?
When a negative supply shock is accommodated, the immediate result is a less severe recession because demand is supported by policies like lower interest rates or increased government spending. However, the downside is that inflation may rise, and stagflation could occur, where the economy experiences high inflation and high unemployment simultaneously.
Accommodation is the lubricant and not the engine of inflation”. Explain this statement.
This means that accommodation (like when a central bank lowers interest rates or increases the money supply to support the economy) isn’t what originally causes inflation
For an expansionary demand shock that opens an inflationary gap, even though the economy could automatically adjust and return to potential, continued validation would result in a persistent inflationary gap as well as sustained inflation.
An expansionary demand shock creates an inflationary gap by pushing output above the economy’s potential. Normally, the economy would self-correct as rising prices and wages slow things down. But if policymakers keep supporting demand (like with low interest rates or extra spending), they validate the gap. This prevents adjustment and leads to persistent inflation, since the economy keeps running hot instead of cooling off.
