Combating the Recession with monetary policy

1. In order to combat a recession and stimulate the economy, the MPC cuts the repo rate.

As a result of this, banks cut their interest rates too. This results in an increase in the money supply as people are paying less interest on their loans and are borrowing more.

A decrease in the interest rate increases the supply of money and as a result of this, the quantity of money demanded increases.

In the LR, an increase in the supply of bank loans is followed by an increase in the price level.

An increase in the supply of bank loans increases the supply of loanable funds from SLF0 to SLF1 and the real interest rate falls. Investment does, however, increase.

The increase in the supply of loans and decrease of the real interest rate increases aggregate planned expenditure. The increase in aggregate planned expenditure increases aggregate demand.

The aggregate demand curve shifts rightwards from AD0 to AD1 and because of the multiplier effect, the economy is now on full employment. The result of a cut in repo rate is a rise in inflation and economic growth.

2.

In order to fight inflation, the MPC must increase the repo rate. Increasing the repo rate will not help the economy grow especially in this post-recession time. Unfortunately, increasing the repo rate and fighting inflation means that the unemployment rate will not diminish. It is because of this the MPC faces a trade-off. Fight the recession by reducing the repo rate and risk missing their inflationary target or increase the repo rate to fight inflation and unemployment may not diminish.

3.

The inflation targeting policy of the South African Reserve Bank is a monetary policy strategy that aims at making a commitment to achieve an explicit inflation target and explain how its policy action will achieve that target.

List of References:

· PARKIN, M, POWELL, M, MATTHEW, K, 2008. Economics (7e). Essex, England: Pearson.