Tuesday, November 12, 2013


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.

No comments:

Post a Comment