Econ

• When a central bank cuts interest rates

  There is a risk of demand-pull inflation as a trade-off as a conflict of macro objectives
• Expansionary monetary policy is successful at lowering interest rates


  Aggregate demand shifts right
• Aggregate demand shifting right

  Higher growth and lower unemployment but higher demand pull inflation
• Lower interest rates stimulate aggregate demand


  Can widen a current account deficit
• Liquidity trap


  When interest rates are already so low, consumers and businesses have already converted their illiquid financial assets into more liquid assets like cash, so further interest rate cuts will not be effective
• Interest rates fall


  Rate of return on savings falls, potentially becoming negative if inflation is higher than nominal interest rates
• Expansionary monetary policy comes with time lags, taking 18 months to 2 years to fully feed through into the economy
• Output gap


  The difference between actual output and potential output
• Economy is close to full employment with small negative output gap


  Interest rate cuts will boost demand but not see much growth or reduction in unemployment, just higher inflation
• Economy in deep recession with large negative output gap


  Interest rate cuts have greater potential to boost growth and reduce unemployment without much demand-pull inflation
• Consumer confidence


  Consumers need to be confident in their job prospects and future income to be incentivised to borrow and spend when interest rates are lower
• Business confidence


  Businesses need to be confident in future demand and profitability to be incentivised to borrow and invest when interest rates are lower
• Banks are unwilling to lend


  Interest rate cuts by the central bank will be ineffective
• Banks do not fully pass on interest rate cuts


  Boost to aggregate demand will be limited
• Larger interest rate cuts


  More effective at boosting aggregate demand through increased borrowing and disposable income
• If interest rate cuts are ineffective, central banks may use alternative measures like quantitative easing
• Price elasticity is calculated by dividing the percentage change in quantity demanded (Qd) by the percentage change in price (P). If the result is greater than one, demand is considered elastic; if less than one, it's inelastic.