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Discuss the effectiveness of expansionary monetary policy in achieving an increase in Aggregate Demand in an economy

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Introduction

Discuss the effectiveness of expansionary monetary policy in achieving an increase in AD in an economy Expansionary monetary policy is monetary policy which is designed to increase aggregate demand. This is achieved, by channelling more savings into investment, therefore if expansionary monetary policy has forced an increase in aggregate demand (AD), and then there will be more capital/ cash available to flow around the country. This increase in aggregate demand is forced by a decrease in interest rates. By decreasing interest rates, it is easier to take out a loan, and therefore people will have more confidence to increase their personal spending. ...read more.

Middle

As there is a drop in interest rates, aggregate demand increases, and forces aggregate price levels to increase. Also, the long run aggregate supply will shift right, increasing the real GDP substantially. Although it would be beneficial to have expansionary monetary policy to get money circulating around the economy, expansionary monetary policy may force a potential for a depreciation in exchange rates, and currency value, therefore even with an increase in GDP, the value of currency would depreciate. Moreover with the potential for currency to decrease in value, the cost of imports will increase, and therefore, cost of living would possibly rise. ...read more.

Conclusion

For example; it is much easier to change an interest or a base rate, but much harder to make changes in taxations etc. Finally, expansionary monetary policy may also force the multiplier effect to take place, for example, with a new increase in spending, there will be a natural increase in business investment, which will increase the businesses production, and sales, thus increasing employee wages, giving them more money to spend in the economy, and the cycle starts again, this in the short term forces monetary policy to become much more effective. ?? ?? ?? ?? Charlie vale RGP Mrs Woodman ...read more.

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Here's what a star student thought of this essay

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Response to the question

This essay has potential, however the ideas are not fully explained. There is an explanation of why expansionary monetary policies would cause an increase in aggregate demand, but there is little discussion of effectiveness beyond time lags. I say this ...

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Response to the question

This essay has potential, however the ideas are not fully explained. There is an explanation of why expansionary monetary policies would cause an increase in aggregate demand, but there is little discussion of effectiveness beyond time lags. I say this essay has potential as it includes sentences such as "perhaps the stability of a countries currency has a dominating effect on how effective monetary policy can be over all" which show perceptive evaluation. It is phrases such as "the effectiveness depends upon" which are missed out on, though, making for a clearer argument.

Level of analysis

The analysis in this essay is sound, yet the explanations are poor at times. The essay asserts "expansionary monetary policy may force a potential for a depreciation in exchange rates" rather than explaining that there will be a decrease in the demand for pounds, due to less attractive interest rates for investors. Also, I would note the analysis needs to be more clinical. "By decreasing interest rates, it is easier to take out a loan" should be replaced with a reference to cheaper and more affordable. Using the relevant terms will gain credit, as this shows stronger understanding. It was nice to see a diagram included, however they have not used it to its best effect. For a start, it's best to draw the Keynesian aggregate supply curve, as it lends itself to evaluation around the varying effects based on the position along the curve. The diagram is not explained in the essay. It shows a shift, which is strong, but there needs to be an accompanying sentence. For example "A decrease in interest rates causes more disposable income for families on a mortgage. Assuming this money is spent, not saved, aggregate demand will shift from AD to AD1. This will cause the price level to increase from P to P1 and real GDP to increase from Q to Q1." A sentence like that is incorporating all the necessary analysis. As mentioned earlier, the evaluation of effectiveness is simply not there! There needs to be discussion of monetary policies including value judgements (how much to decrease the interest rate), the obvious limitation when you get to low levels of interest (such as today), the time lag in companies reacting to a change in the base rate, whether people will spend the money or save (marginal propensity to consume). Such discussions would gain top marks, so it was a shame not to see them!

Quality of writing

The structure in this essay is poor. The introduction doesn't get to the point and waffles on, and there is no conclusion due to the lack of evaluation. The style is poor at times, with the explanations sometimes feeling clunky. For example "As there is a drop in interest rates, aggregate demand increases, and forces aggregate price levels to increase." should be rephrased to "A drop in interest rates will cause aggregate demand to increase and shift right, thus causing the price level to increase". The key word is cause. Spelling, punctuation and grammar are fine. I liked the use of terms such as "moreover" and "perhaps" as it shows the potential of some critical language.


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Reviewed by groat 10/03/2012

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