Generally recognized as a sign of a policy favoring tighter money is a a. rise...

Generally recognized as a sign of a policy favoring tighter money is a
a. rise in the discount rate
b. rise in government bond purchases by the CB
c. rise in the money supply
d. reduction of the required reserve ratio?

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Answers (2)

3 months ago
a. rise in the discount rate
3 months ago
Tight monetary policy implies the Central
Bank (or authority in charge of Monetary
Policy) is seeking to reduce the demand
for money and limit the pace of economic
expansion. Usually, this involves increasing
interest rates.
The aim of tight monetary policy is usually
to reduce inflation.
With higher interest rates there will be a
slowdown in the rate of economic
growth. This occurs due to the fact higher
interest rates increase the cost of
borrowing, and therefore reduce
consumer spending and investment,
leading to lower economic growth.
Tight monetary policy can also be termed
– deflationary monetary policy.
Tight monetary policy will typically be
chosen when inflation is above the
inflation target (of 2%) or policymakers
fear inflation is likely to rise without a
tightening of monetary policy. For
example, in the early 1980s, the
government increased interest rates in
response to higher inflation. This caused
inflation to peak in 1980 and then fall.
In the late 1980s, we also see a tightening
of monetary policy. The economy was
growing rapidly and inflation starting to
rise. In response, the government
increases interest rates.
Tight Monetary policy involves
1. Raising Interest Rates
The Bank of England could raise the base
interest rate. This base rate tends to affect
all the other interest rates in the economy;
this is because commercial banks have to
borrow from Bank of England, so if the
base rate rises, commercial banks tend to
put up their own borrowing and saving rates.
Higher interest rates tend to reduce
aggregate demand (AD) because:
Borrowing becomes more expensive.
Therefore firms and consumers are
discouraged from investing and
Saving becomes more attractive.
Therefore firms and consumers are
more likely to keep saving money in the
bank rather than spend.
Reduced disposable income.
Consumers with a variable mortgage
will see a rise in monthly mortgage
interest payments. Therefore, they will
have less income to spend.
Exchange rate effect. By raising interest
rates, the exchange rate tends to
appreciate because of hot money flows
taking advantage of better saving rates
in that country. An appreciation of the
exchange rate will also help reduce
inflationary pressure. Imports will be
cheaper. Also, there will be less demand
for exports, leading to a decline in
aggregate demand The decline in
competitiveness may encourage firms
to be more efficient and cut costs
2. Open Market Operations
The Central bank can also tighten
monetary policy by restricting the supply
of money. To do this, they can print less
money or sell long-dated government
bonds to the banking sector. By selling
bonds, banks see a reduction in liquidity
and therefore reduce lending.
A central bank could also raise the
minimum reserve ratio. This forces banks
to keep more liquidity in banks.
In practice, open market operations are
not used very frequently.
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