IB Economics Topic 3.5.8 Effectiveness of Monetary Policy Revision Notes (SL/HL)

IB Economics Topic 3.5.8 Effectiveness of Monetary Policy Revision Notes (SL/HL) | RevisionDojo

Written by official IB examiners

Constraints on monetary policy

Monetary policy is not always effective due to constraints such as:

Limited scope of reducing interest rates, when close to zero
Low consumer and business confidence
Inability to deal with cost-push inflation

Limited scope of reducing interest rates, when close to zero

When the central bank wants to employ an expansionary monetary policy by reducing interest rates, it cannot lower interest rates below 0%.
Thereby, if the central bank does not achieve its goal before the interest rate reaches 0%, then monetary policy may become ineffective.

Example

During the 2008 financial crisis, many central banks reduced interest rates to near zero. However, the economies did not recover quickly as the interest rates drops near zero did not incentivise consumers or investors to spend significantly more.

Low consumer and business confidence

Even with low interest rates, if confidence is low about the future economic conditions, people may still avoid borrowing and spending money.
For example, businesses may delay investments if they are uncertain about the economic outlook.
Therefore aggregate demand may not increase, hence making monetary policy ineffective.

Example

During the COVID-19 pandemic, despite low interest rates, many businesses and consumers held back on spending due to uncertainty about the future.

Inability to deal with cost-push inflation

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Excepteur sint occaecat cupidatat non proident

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Tip

Lorem ipsum dolor sit amet, consectetur adipiscing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua. Ut enim ad minim veniam, quis nostrud exercitation ullamco laboris nisi ut aliquip ex ea commodo consequat.

Lorem ipsum dolor sit amet, consectetur adipiscing elit.
Sed do eiusmod tempor incididunt ut labore et dolore magna aliqua.
Ut enim ad minim veniam, quis nostrud exercitation ullamco laboris.
Duis aute irure dolor in reprehenderit in voluptate velit esse cillum.

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Constraints on monetary policy

Monetary policy is not always effective due to constraints such as:

Limited scope of reducing interest rates, when close to zero
Low consumer and business confidence
Inability to deal with cost-push inflation

Limited scope of reducing interest rates, when close to zero

When the central bank wants to employ an expansionary monetary policy by reducing interest rates, it cannot lower interest rates below 0%.
Thereby, if the central bank does not achieve its goal before the interest rate reaches 0%, then monetary policy may become ineffective.

Example

Low consumer and business confidence

Even with low interest rates, if confidence is low about the future economic conditions, people may still avoid borrowing and spending money.
For example, businesses may delay investments if they are uncertain about the economic outlook.
Therefore aggregate demand may not increase, hence making monetary policy ineffective.

Example

During the COVID-19 pandemic, despite low interest rates, many businesses and consumers held back on spending due to uncertainty about the future.

Inability to deal with cost-push inflation

Definition

Paywall

(on a website) an arrangement whereby access is restricted to users who have paid to subscribe to the site.

anim nostrud sit dolore minim proident quis fugiat velit et eiusmod nulla quis nulla mollit dolor sunt culpa aliqua

Duis aute irure dolor in reprehenderit

Note

Lorem ipsum dolor sit amet, consectetur adipiscing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua. Ut enim ad minim veniam quis nostrud exercitation.

Excepteur sint occaecat cupidatat non proident

Tip

Lorem ipsum dolor sit amet, consectetur adipiscing elit.
Sed do eiusmod tempor incididunt ut labore et dolore magna aliqua.
Ut enim ad minim veniam, quis nostrud exercitation ullamco laboris.
Duis aute irure dolor in reprehenderit in voluptate velit esse cillum.

1. Introduction to Economics2 subtopics

2. Microeconomics12 subtopics

3. Macroeconomics7 subtopics

4. The Global Economy10 subtopics

IB Economics 3.5.8 Effectiveness of Monetary Policy Notes

1. Introduction to Economics2 subtopics

2. Microeconomics12 subtopics

3. Macroeconomics7 subtopics

4. The Global Economy10 subtopics

Constraints on monetary policy

Limited scope of reducing interest rates, when close to zero

Low consumer and business confidence

Inability to deal with cost-push inflation

anim nostrud sit dolore minim proident quis fugiat velit et eiusmod nulla quis nulla mollit dolor sunt culpa aliqua

Duis aute irure dolor in reprehenderit

Excepteur sint occaecat cupidatat non proident

Unlock the rest of this chapter with a free account

Constraints on monetary policy

Limited scope of reducing interest rates, when close to zero

Low consumer and business confidence

Inability to deal with cost-push inflation

anim nostrud sit dolore minim proident quis fugiat velit et eiusmod nulla quis nulla mollit dolor sunt culpa aliqua

Duis aute irure dolor in reprehenderit

Excepteur sint occaecat cupidatat non proident

Unlock the rest of this chapter with a free account