Weaknesses of Monetary
Policy
Weaknesses of Monetary Policy
1. Impact Lag:
• It has been noted by many economic commentators
that there can be a significant impact lag associated
with the implementation of monetary policy.
• In general, it is safe to assume that there is a 12-18
month lag after any change in interest rates before it
will have an impact on the economy.
• A 1% change in interest rates has a 0.75% effect on
GDP
• 40% of a rate change has impact in first 12 months
• 80% of rate change felt after 2 years
• 100% after 3 years
Weaknesses of Monetary Policy
2. Blunt instrument:
• Monetary policy affects all participants in the
economy. It is non selective, unlike budgetary policy.
Sectors of the economy not doing well even in times
of a boom will be effected substantially by a rise in
interest rates.
• When interest rates are increased, any business or
consumer with a loan will have to pay a higher rate
of interest in order to finance that loan, no matter
what there circumstances.
Weaknesses of Monetary Policy
3. Effectiveness:
• monetary policy is more effective when employed to
slow the economy and combat inflation than it is to
stimulate it.
• To stimulate the economy as you need business and
consumer confidence to increase before people start
spending extra discretionary income and business
start to invest.
• Proof of this has been since the GFC in 2007, many
economies have had zero real interest rates (Japan,
U.S., France, Spain) but have been unable to
stimulate economic growth.