ECON2200 Short Answer Questions

ECON2200 Short Answer Questions - E xplain what economists...

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Explain what economists mean by the statement, "Commercial (private-sector) banks tend to feed booms and starve recessions.” (Use the QTM to explain.) Given the relationships you have described, why do some economists argue for countercyclical monetary policies? 1. Commercial banks “feed booms” What does this mean in terms of the Quantity Theory of Money? Well, a boom is just an increase in Y (real output is expanding). When M , Y . Also, when M , P (resulting in inflation). Therefore, during the period of a boom, the job of the central bank is to monitor the inflation rate ( Countercyclical monetary policy - to decrease the growth rate in M in order to avoid inflation). What is meant by countercyclical? The fed (central bank) is almost always going in the opposite direction than the private sector would go on it’s own. 2. Commercial banks “starve recessions” “Recession” in terms of the Quantity Theory of Money is a decrease in Y. During a recession when businesses are failing and the economy is declining, banks reduce their loans so the money supply decreases. M , Y . What did the fed do? Lowered interest rates and expanded the money supply to counter this cycle. Therefore, the countercyclical monetary policy in this case would be to M in order to encourage real output growth ( Y). *Know: at the moment there is no fed or central bank doing this stuff; doesn’t happen until
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ECON2200 Short Answer Questions - E xplain what economists...

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