2. 1. Because of the problem of lags, monetary authorities should probably respo

Question

2. 1. Because of the problem of lags, monetary authorities should probably respond to conditions:

a. Immediately as they arise.

b. Expected to exist in the future.

c. In the recent past.

d.Based on past statistics.

2. An expansionary monetary policy by the Fed should lead to:

Leave investment unchanged but decrease aggregate demand.

An increase in investment and a decrease in aggregate demand.

A decrease in investment and a decrease in aggregate demand.

An increase in investment and an increase in aggregate demand.

Leave investment unchanged but decrease aggregate demand.

An increase in investment and a decrease in aggregate demand.

A decrease in investment and a decrease in aggregate demand.

An increase in investment and an increase in aggregate demand.

Explanation / Answer

2. Sol:- b- Expected to exist in the future

BriefExplanation:-

The impact lag for monetary policy occurs for several reasons. First, it takes some time for the deposit multiplier process to work itself out. The Fed can inject new reserves into the economy immediately, but the deposit expansion process of bank lending will need time to have its full effect on the money supply. Interest rates are affected immediately, but the money supply grows more slowly. Second, firms need some time to respond to the monetary policy with new investment spending—if they respond at all. Third, a monetary change is likely to affect the exchange rate, but that translates into a change in net exports only after some delay. Thus, the shift in the aggregate demand curve due to initial changes in investment and in net exports occurs after some delay. Finally, the multiplier process of an expenditure change takes time to unfold. It is only as incomes start to rise that consumption spending picks up.

The problem of lags suggests that monetary policy should respond not to statistical reports of economic conditions in the recent past but to conditionsexpected to exist in the future. In justifying the imposition of a contractionary monetary policy early in 1994, when the economy still had a recessionary gap, Greenspan indicated that the Fed expected a one-year impact lag. The policy initiated in 1994 was a response not to the economic conditions thought to exist at the time but to conditions expected to exist in 1995. When the Fed used contractionary policy in the middle of 1999, it argued that it was doing so to forestall a possible increase in inflation. When the Fed began easing in September 2007, it argued that it was doing so to forestall adverse effects to the economy of falling housing prices. In these examples, the Fed appeared to be looking forward. It must do so with information and forecasts that are far from perfect.

2. Sol:- d- An increase in investment and an increase in aggregate demand

Explanation:-

Expansionary policy attempts to promote aggregate demand growth. As you may remember, aggregate demand is the sum of private consumption, investment, government spending and imports. Monetary policy focuses on the first two elements. By increasing the amount of money in the economy, the central bank encourages private consumption. Increasing the money supply also decreases the interest rate, which encourages lending and investment. The increase in consumption and investment leads to a higher aggregate demand.

It is important for policymakers to make credible announcements. If private agents (consumers and firms) believe that policymakers are committed to growing the economy, the agents will anticipate future prices to be higher than they would be otherwise. The private agents will then adjust their long-term plans accordingly, such as by taking out loans to invest in their business. But if the agents believe that the central bank's actions are short-term, they will not alter their actions and the effect of the expansionary policy will be minimized

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