Monetary Policy

Recently, concern was expressed over stimulating the economy in a recession and how loans are affected. The monetary policy is not as effective when the demand for loans is low, even with low rates. The demand for the loans may decline because of

consumer confidence. As the demand for loans shrinks, the effectiveness of changing interest rates decreases. The demand for loans is based on the cost of the loan but also on the consumption by the consumer. If the consumer is not purchasing products or services then the interest rate does not make any difference. There may be available money and it may be at an attractive rate, but if the people that borrow think there is reason to

worry about the economy, there may be hesitation and postponement.

The consumer interest in buying is related to their ability to pay. In a declining economy, consumers will stop or put off purchasing products. This is an expected reaction to concerns about future employment.

Unemployment can also lower the demand for loans, or cause people to default on loans. Rising loan defaults could make lenders wary enough that a slowdown in credit expansion, particularly to risk-based consumers, could hamper businesses and lower loan production.

Another concern is risks to other macroeconomic measures. The risk to GDP is that it will decrease with monetary policy designed to slow inflation. The risk to unemployment is that it will increase with that same monetary policy. Timely adjustments in monetary policy can help to stabilize employment and output growth. Low and stable inflation may contribute to an unemployment rate that is on the average lower than it would otherwise be at a higher rate of inflation. The monetary authority does not have the power to prevent all fluctuations in output and employment and trying too hard could lead to destabilizing the inflation rate, which would create additional problems.

In order to mitigate the associated risks, the monetary authority needs to

understand how the different measures are tied together, some directly

and some inversely. Slow inflation can cause negative effects on the economy because of changes in consumer behavior and business decisions. The inability to raise prices can squeeze profits and leave companies with less money to expand, which could contribute to the unemployment rate. They also need to understand that