1. Keynes had doubts on the effectiveness of monetary policy during recession. E
ID: 1220446 • Letter: 1
Question
1. Keynes had doubts on the effectiveness of monetary policy during recession. Explain two reasons.
2.Show graphically an example of the Keynesian equilibrium which occurs at less than the full employment output level. Also explain what problem an economy may experience in this situation and how the economy can overcome the problem.
3. As an economy grows wage opportunities may grow for women. Discuss the implication on population growth from the perspective of Becker. Be sure to explain in detail in the context of his household model.
4. The number of meals consumed at restaurants in the United States has increased more rapidly than the number of meals consumed at home. Use Becker’s theory to explain this.
Explanation / Answer
Q1. Keynes had doubts on the effectiveness of monetary policy during recession -
The two reasons behind his doubt are as follows -
1. Keynes was of the view that during recession interest rates were already at very low level and because of this liquidity preference curve is absolutely elastic or is of horizontal shape during recession. In such scenario, any fall in interest rate due to conduct of expansionary monetary policy will have no impact that is interest rate will not fall further and thus there would be no pick up in investment demand as desired by the conduct of expansionary monetary policy and thus monetary policy will be ineffective in impacting the recessionary conditions in positive manner.
2. According to Keynes, investment demand depends on the rate of interest and marginal efficiency of capital. Rate of interest is determined by supply of money and state of liquidity preference and marginal efficiency of capital is determined by profit expectations of entrepreneurs.
According to him, rate of interest is more or less sticky and it is frequent changes in profit expectations of the entrepreneur that is change in marginal efficiency of capital that majorly impacts the investment demand by entrepreneurs. During recession, investors are generally pessimistic about profit earning in future and in such scenario fall in interest rate due to conduct of expansionary monetray policy is of no help as until and unless the profit expectation of businesses will not change in positive manner their investment demand will remain subdued whatever be the rate of interest. So, monetary policy in such situation will remain largely be ineffective.
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