Monetary Policy and Its Implications for the Economy

Monetary Policy and Its Impact on Economic Volatility

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Question

Which of the following is/are true about monetary policy?

I. The money supply is neutral in the long-run.

II. Monetary policy can only serve to decrease economic volatility.

III. Of the monetary aggregates, Central Bankers only have direct control over the monetary base.

Answers

Explanations

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A. B. C. D. E. F.

C

In the long-run, relative prices are important, not the price level itself. To understand why, imagine if your salary increased by ten times but so did the price of all the goods you buy. This would be a neutral event.

If money is neutral, then monetary policy can have no long-term effect. However, in the short-term, changes in the price level can cause producers to change their production choices, ostensibly helping to smooth out the business cycle.

Central Bankers generally have control over the bank reserve requirement and the level of currency. They do not have control over the amount of currency individuals put into deposit accounts which could later be lent out by banks. Hence, Bankers control the monetary base, but not other money aggregates such as

M2 and M3.

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