Monetary policy is obviously important, but how does it
actually affect the economy? The answer is very complicated, but the text did
seem to indicate what some of these effects may be. Monetary policy is
important macroeconomically, especially for those concerned with inflation.
Thus, it's important to note that many monetarists want a monetary policy that
creates a stable framework and inflation rates that vary widely is an obvious
interruption to that stable framework. This brings into question how high or
low the inflation must be since it drastically affects monetary policy, and the
economy as a whole. The monetary policy of the United States is fairly
consistent, as shown in the very stable inflation rate, but why is the current
level of inflation considered better than a very high rate or a very low rate?
Well, reducing inflation is believed to create recession and unemployment by
lowering the incentive for investment, while high inflation rates mean that
prices rise very fast (obviously bad). Also, it's useful to note that reducing
inflation is not technically difficult in the U.S., but there are political
barriers.
Money is technically an illusion, so people think in nominal
terms and not in real terms, so the full effects of deflation are not always
clear in the global economy. When prices rise it's usually a sign that an
economy has problems, but when they rise slowly and consistently at a stable
rate it's usually considered to be a positive indicator. As a result, zero
inflation without deflation would mean the economy must be even more stably,
but that's not the case and this is powerful in explaining current monetary
policy. Why is a low level of inflation considered healthy or stimulus to the economy rather than no level of inflation (for reasons other than incentive for investment)? I believe the answer can easily fill a book.
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