Answer to Question #284312 in Macroeconomics for haseeb

Question

Suppose that you are the member of the Board of Governors of

the State Bank. The economy is experiencing the severe

unemployment. What changes in

A. The Reserve Ratio

B. The Discount Rate

C. Open Market Operations

would you recommend? Explain in each case how the change you

advocate would affect the money supply, interest rate and aggregate

demand and authenticate your arguments with monetary transmission

mechanism diagram.

Answer 1

In the event of severe unemployment, the Central Bank should pursue a soft policy.

Soft policy. In accordance with this type of monetary policy, the state influences different levels of the economy and interest rates. At the same time, the Central Bank carries out such operations as: - purchase of securities on the stock market; - controls and tries to reduce the bank reserve ratio; - adjusts the interest rate downward.

Expansionary monetary policy assumes that the central bank buys treasury bonds, reduces interest rates on loans to banks or reduces reserve requirements. All these actions increase the money supply and lead to lower interest rates.

This creates incentives for banks and businesses to take out loans. The expansion of debt-financed businesses can have a positive impact on consumer spending and investment through employment, thereby increasing aggregate demand.