Question

How do tight and loose monetary policy affect interest rates?

a) Tight policy lowers interest rates; Loose policy raises interest rates
b) Tight policy raises interest rates; Loose policy lowers interest rates
c) Both tight and loose policy lower interest rates
d) Both tight and loose policy raise interest rates

Answer 1

Tight monetary policy raises interest rates, reducing borrowing and spending, while loose monetary policy lowers interest rates, encouraging borrowing and investment.

Step-by-step explanation:

Tight monetary policy generally raises interest rates to curb inflation and control economic overheating. This makes borrowing more expensive and less attractive, which can lead to decreased consumer and business spending. On the other hand, a loose monetary policy lowers interest rates to stimulate the economy, making loans cheaper and encouraging more borrowing and investment. This can increase consumer spending on big-ticket items like houses and cars and boost business investment in physical capital.

During economic downturns, like the 2008-2009 recession, central banks might engage in quantitative easing, which is a form of expansionary monetary policy that aims to increase the money supply and lower interest rates even further to encourage lending and investment. Both types of policies are important tools for central banks managing the country's economic goals, including employment levels and price stability.