Macroeconomic

Chapter 10

A-17 Part A)

The terminology most economists would use to describe quantitative easing is monetary policy. Quantitative easing is a non-traditional monetary policy in which the central bank purchases government bonds and securities from the market in a bid to reduce the interest rates and increase the supply of money. This policy increases the money supply by injecting capital in the financial institutions, with the aim of increasing lending and liquidity.

A-17 Part b)

The aim of central bank by employing quantitative easing is to affect the supply of money by either buying or selling government securities or bonds. When the central bank aims to increase economic growth, it purchases government bonds and securities. This lowers the interest rates and increases the supply of money in the market. The lowering of interest rates is aimed to encourage commercial banks to increase lending. Lower interest rate would lead to higher consumer borrowings from commercial banks. This is how quantitative easing targets bank lending.

A-17 Part c)

The 2007 crisis was marred by credit problems. It involved bankruptcies, insolvencies, layoffs and mortgage failures. Therefore, the commercial banks were reluctant to lend finance, as insolvencies and bankruptcies were widespread due to the credit crises in 2007.

A-19 Part a)

The lenders and borrowers are nervous in the periods of recession. The reason is that the negative economic climate creates an atmosphere of uncertainty. If quantitative easing monetary policy is applied in a bid to lower interest rates during periods of recession, it would not have any significant effect. The private individuals are concerned about their jobs, as during recessions there are widespread lay-offs and redundancies. Hence, the people are more inclined towards saving then borrowing as they fear that in case they lose their jobs, it would be difficult to pay off the loans. The businesses are also reluctant to borrow because of the negative economic climate, they fear that there investment might not be successful. Hence, in periods of recessions, quantitative easing might not yield the required results and increase banks lending.

A-19 Part b)

Stimulating effect refers to the manipulation of fiscal or monetary policy in a way that stimulates aggregate demand in the economy. Stimulating effect can be achieved by lowering the rates of interest by applying the quantitative easing policy. When the interest rates goes down, the consumers are likely to borrow more from banks, as the supply of money would have increased in the market. However, this would have a smaller impact in times of recession then in normal circumstances. The reason is that the period of recession creates uncertainty in the economy. Therefore, the reduction in interest rates might not create a stimulus effect after all.

A-19 Part c)

Income multiplier is described as one divided by the marginal propensity to save. This is the relationship between how much an individual would be willing to save in response to an increase in the supply of money. However, it is mentioned that even when the bank reserves increased in enormous levels, this did not encouraged increase in marginal propensity ...