VCE Stuff > VCE Economics

Why does monetary policy exist?

<< < (2/2)

Eriny:
I'm not saying that things like inflation and so on won't exist without monetary policy, but it does have a tendency to soften the extremes of recession and boom. The market doesn't seem to be able to do this by itself.

Collin Li:

--- Quote from: Eriny on October 09, 2008, 10:38:16 am ---I'm not saying that things like inflation and so on won't exist without monetary policy, but it does have a tendency to soften the extremes of recession and boom. The market doesn't seem to be able to do this by itself.

--- End quote ---

It depends whether you believe booms and busts are actually a bad thing. Then you have to ask, does the prescription make things better, or does it worsen things? Sure, it may smooth output, but why should we smooth it anyway?

The business cycle may very well be due to real shocks in the economy, and the modern economy is simply reacting to these shocks. See the Real Business Cycle Theory for one such theory. The Keynesian theory is also acceptable, and it states that the booms and busts are rational responses to shocks, but they are still "inefficient" (market failures) due to price-stickiness (which is rational, due to menu costs and information inefficiency - efficient by "bounded rationality").

I don't have an answer as to whether monetary policy (the prescription) makes things better. If there is information inefficiency, I don't see how monetary policy will fix this. It just follows a rule of smoothing output, and this seems irrelevant to an economy that just wants to be able to react to real shocks.

Eriny:
Well, I think that overall growth is higher when the economy is more resistant to major shocks and isn't rife with extremes. I would value small fluctuations over big ones.

Navigation

[0] Message Index

[*] Previous page