Posts Tagged ‘monetary policy’

Predicting the Effects of Expansionary Monetary Policy on an Economy in Recession

October 21, 2009

The Obama Administration has enacted both of Keyne’s creeds: Expansionary Monetary Policy and Deficit Spending. This article will focus on the former.

Expansionary monetary policy is enacted to lower interest rates in times of deflation. This encourages investment, and ideally improves the economy and brings it out of recession. However, this Keynesian analysis is limited. After the economy recovers due to a particularly large session of EMP, hyperinflation occurs. Hyperinflaiton is inflation to the point where interest rates rise as if deflation were occuring. This is due to the fact that interest rates must necessarily be above that of the inflation rate, or banks face immediate deficits.

This increased interest rate necessarily passes the inflationary burden onto businesses. This pushes them into deficits of their own, and many businesses have to lay off workers in order to restore their profits. This is the harmful effect of hyperinflation, which can occur if enough EMP is enacted at once.

Though hyperinflation is destined to occur to this recession, there are other harmful effects of EMP that happen every time expansionary monetary policy is implemented. Any time interest rates are artificially lowered, more loans are taken out and less money is saved. This often leads to a “boom”, like the one of 2002 to 2006. However, when the market over invests poorly as a result of this policy, the result is always the same: the economy lurches into recession. Savings have been consumed and most people have spent and investedĀ themselves into large loans. The recession then ensues.

What then, occurs when, as we are now, we implement EMP during a recession? Such an event causes a double-dip recession. The economy spends itself even more up to a point, and then the economy collapses in debt again. This has happenedĀ more than once since it happened in the Great Depression.

Expansionary monetary policy is necessarily a harmful policy to implement on society in mass quantities at any time. The proper solution is to let the market painfully recover from its government-stimulated overinvestment. Haste makes waste.