The Effectiveness of Monetary Policy
- Monetary policies relies on accurate information, so it follows that if the information is not accurate, it is likely that the monetary policy will be ineffective
- Monetary policy instruments can be hard to control
- g. it’s hard to control the money supply, as banks have an incentive via profit to lend more.
- Controlling the interest rate is one of the most common policy instruments
- It is often the case that the MPC will set the rate of interest too high – which limits economic growth – due to being scared of the prospect of inflation
- It takes time for changes in the rate of interest to have an effect on the economy, e.g. banks don’t change their interest rates quickly, and it takes time for the components of aggregate demand to change, and hence impact AD
- AD may not change much due to changed interest rates, e.g. if firms and consumers are optimistic abut the future, increasing the interest rate won’t stop them spending
- Some countries don’t have control over their interest rate if they’re part of monetary unions such as the EU
- If interest rates are at already low levels, further cuts are likely to be ineffective, e.g. if the interest rate is at 1%, why would someone who’s not prepared to borrow be convinced by it falling to 0.5%?
- Monetary policy tends to only effect certain groups, e.g. a rise in the interest rate will hit firms that export a high proportion of their output more than other firms, due to a fall in demand and higher costs.
- Monetary policy instruments can have side effects, e.g. rising the exchange rate to reduce inflation may worsen balance of payments position.