Page 244 - DECO402_Macro Economics

Unit-27: Monetary Policy

encourages consumer and trade credit. Through these Notes
measures it reduces the cost and availability of credit in
the money market and improves the economy.
Expansionary monetary policy has been described through
figure 27.1 (A) and (B). where initial recession is at R, Y, P, Q.
In part (A) of the figure economy in already at extra money
supply are interest rate OR. Consider that due to the credit
policy of the central bank there is an increase in money
supply in the economy. It shifts the curve LM rightwards
to LM . It increases the income from OY to OY and entire
1
1
demand increases and in part (B) curve D shifts upwards to
D . Along with increase in demand for goods and services,
1
production at high price level OP rises from OQ to OQ . If
1
1
expansionary monetary policy works properly then balance
at point E may take place at full employment. But because
1
of the below mentioned limitations possibility of reaching
to that situation is not there.
Its Scope and Limitations

During the decades of 1930 and 1940 it was believed that
in comparison to controlling boom and inflation, success of
monetary policy was very limited in inducing recovery in
depression. This concept emerged from the experiences of Figure 27.1
the great depression and publishing of the general theory
of the Keynes.
Monetarists’ opinion is that during depression central bank through cheap credit policy may increase
the reserves of the commercial banks. It may do so by purchasing securities or by decreasing the interest
rates. As a result by increasing the facilities of those taking loans, banks’ capacity will increase. But
experience of the great depression tells that during sharp depression when traders are pessimistic,
then practically success of such policy is zero. In such situation banks are helpless on bringing revival.
Since trade activities are almost in the situation of stagnancy hence traders have no tendency for
taking loans to make inventories, though interest rates are very less. Since they want to reduce their
already taken loans for inventories by returning. Apart from this question of taking loans for long
term requirements does not arise in depression, when trade activity is already at very low level. With
consumers also the condition is same who are struggling with reduced income and unemployment.
Hence they do not wish to purchase any durable goods through bank loans. In this manner all banks
may make credit available but they cannot compel traders and consumers to accept it. In the decade
of 1930, very low interest rates and unused reserve amount with banks could have any important
impact on world’s economies with depression.
“It is not said that during sharp contract cheap monetary policy will with without any profitable
impact, but its most effect will be in preventing a bad situation from reaching to a worst situation.
But restrictive monetary policy associated with downturn business will definitely make downturn
business worse- its traditional example was the monetary policy of 1931 which gave its contribution
in making the great depression serious…. At the other side if credit is easily available at favourable
terms then definitely it will have a stabilising effect. It may become slow on fulfilment of liquidity
requirements of the trade and perhaps may decrease the limit of downturn.”
But what was the cause of collapse of monetary policy in the decades of 1930 and 1940? Apart from
painful and disillusion experiences during the great depression and after it, General Theory of Keynes

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