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Economy Sinks Deeper Into Recession

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The author mentions that monetary policy involves an increase in the money supply. Holding the income and therefore the demand for real money balances constant, this lowers the rate of interest. Hence, the LM curve shifts to the right as a result of the money supply increase. Lower interest rates boost investment in the goods market and increase output (Mankiw, 2008). The fiscal policy and the monetary policy can be initiated simultaneously depending upon the target variable. A tax cut or increase in government expenditure shifts the IS curve upward.

If the central bank holds the money supply, this will raise interest rates and also increase output but less than the multiplier effect. However, if the central bank also increases the money supply so that the interest rate is held constant, the output would be greater. On the other hand, if the central bank reduces the money supply to hold output, the rate of interest would rise by a larger amount than that induced by only the fiscal policy (Mankiw, 2008). The UK economy since 2008Through the 2000s till 2007, interest rates in the United Kingdom were relatively low, which resulted in high economic growth through an increase in aggregate demand.

In particular, house mortgages boomed because of low-interest rates. With the availability of collaterals and liberalization of the credit markets, the housing market has a ‘ wealth effect’ through the stock market. For about a decade, the availability of housing credit and spiraling of house prices, a large number of families accumulated significant wealth (Muellbaur, 2007). The housing market affects monetary policies, hence interest rates, through direct effects on the user cost of capital, expectations of future movements of housing prices and the supply of housing as well as indirectly through effects on the real economy.

The latter influence works through wealth effects of housing prices, credit effects of consumer spending and the subsequent effects on housing demand.

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