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TOS 7. ThoughtCo uses cookies to provide you with a great user experience. The importance of studying economics in today’s world June 4, 2018 1:03 AM Economics helps us identify the policy measures that encourage prosperity and avoid inefficiency, making it … We shall explain how these various tools can be used for formulating a proper monetary policy to influence levels of aggregate output, employment and prices in the economy. Similar to the Cash Reserve Ratio (CRR), in India there is another monetary instrument, namely, Statutory Liquidity Ratio (SLR) used by the Reserve Bank to change the lending capacity and therefore credit availability in the economy. More specifically, at times of recession monetary policy involves the adoption of some monetary tools which tend the increase the money supply and lower interest rates so as to stimulate aggregate demand in the economy, on the other hand, at times of inflation, monetary policy seeks to contract the aggregate spending by tightening the money supply or raising the rate of interest. The following three monetary policy measures are adopted as a part of an expansionary monetary policy to cure recession and to establish the equilibrium of national income at full employment level of output: 1. Every branch of knowledge has its fundamental discovery. Therefore, for all these reasons (especially because of the liquidity trap in the demand for money curve at lower rates of interest), Keynes was of the view that monetary policy is not an effective instrument in bringing about revival of the economy from the depressed state. They therefore emphasized the role of fiscal policy for fighting severe recession. Similarly, when the economy is going into recession, it will result in lowering aggregate output and prices. According to monetarists, there are two important sources of monetary mismanagement. That is, the sum of consumption expenditure, private investment spending and Government expenditure exceeds the full-employment level of output by E1H. Fiscal policy opened up new jobs and increased government spending to right the wrong of the market crash. More private investment will cause aggregate demand curve to shift upward. How Expansionary Monetary Policy Works: Keynesian View: Now, it is important to understand how expansionary monetary policy works to cause increase in output and employment and thus help the economy to recover from recession. (3) To promote and encourage economic growth in the economy. The greater the size of multiplier, the greater the impact of increment in investment on expansion of output and income. On the other hand, in times of inflation and excessive expansion, contractionary monetary policy or what is also called tight money policy is adopted to control inflation and achieve price stability through reducing aggregate demand in the econ­omy. 29.2 is fairly elastic so that rise in rate of interest from r1 to r2 is sufficient to reduce investment by I2 – I1 or ∆I. As long as the money supply grows at a constant rate each year, be it 3, 4 or 5 per cent, any decline into recession will be temporary. How the Tight Monetary Policy Works: Keynesian View: It is important to understand how tight monetary policy works to check inflation. 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