Saturday 21 May 2011

Explain the concept of a “loose monetary policy”.

The term "loose monetary policy" in this context describes how monetary policy (such as interest rates and quantitative easing) were geared more towards promoting growth than restricting it to control the price level, this would suggest that they had a low base rate of interest and were perhaps engaging in high levels of quantitative easing.

The problem with this was that Portugal, Italy, Ireland, Greece and Spain all experienced high levels of inflation which led to a loss of international competitiveness that can be traced back to 1999. The high inflation levels led to a lack of competitiveness as prices in those countries were rising faster than those in other countries, which meant that their goods were relatively more expensive and therefore less competitive. Normally, a country in this situation would opt to increase interest rates, however, as the interest rates for the euro area are set centrally, it can be difficult to cater for the needs of everyone.

2 comments:

  1. You say: "were geared more towards promoting growth than restricting it to control the price level"

    Why restrict growth to control the price level - surely growth increases capacity and thus keeps prices low?

    You say:

    "The high inflation levels led to a lack of competitiveness as prices in those countries were rising faster than those in other countries,"

    Many, many goods do not compete on price eg luxury cars, so why is loss of price competitiveness so important? Surely it is only important where demand is price elastic?

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  2. Growth only keeps prices low if it's supply-led, which theirs is not.

    I also think that there is an element of price competition in everything - although some would indeed be inelastic, an increase in price would still lead to people switching to competitors/ones from other countries.

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