reply to discussion
The Federal Reserve’s monetary policy affects investment in the following ways: restriction and expansion (McConnell et al., 2018). Investment is impacted scenarios, with the direction of impact depending on the which type of monetary policy is employed. In a situation of unemployment and recession, the Federal Reserve can employ an expansionary monetary policy which stimulates investment spending through reserve expansion and increased money supply that lowers interest rates (McConnell et al., 2018). In contrast, a restrictive monetary policy may be employed due to inflation which deters investment spending through reduction of reserves and reduced money supply resulting in higher interest rates (McConnell et al., 2018).
The Federal Reserve’s countercyclical monetary policies have been effective in moderating business cycle swings, but the effectiveness is less dependable in certain situations. “Monetary policy may be highly effective in slowing expansions and controlling inflation but may be much less reliable in pushing the economy from a severe recession” (McConnell et al., 2018, p.738). The Federal Reserve can be highly effective in pulling the aggregate demand curve left through contraction of the money supply and higher interest rates which reduces aggregate demand (McConnell et al., 2018). However, The Federal Reserve is less effective in pushing aggregate demand because of the liquidity trap, in which little to no positive impact on aggregate demand is realized from the addition of more liquidity to banks (McConnell et al., 2018). For example, between 2007 and 2009, billions of dollars were added to reserves, and it drove interest rates down over 4 percentage points which should have increased aggregate demand, lending, borrowing, and investment (McConnell et al., 2018). That was not the immediate reaction though, because banks remained afraid that loans would not be repaid, and the reserves were held instead (McConnell et al., 2018).
McConnell, C. R., Brue, S. L.,