Chapter 15: Problem 15

Monetary policy can affect relative prices. Do you agree or disagree with this statement? Explain your answer.

Short Answer

Expert verified

Yes, monetary policy can affect relative prices. Changes in the money supply or interest rates as a result of monetary policy can stimulate or slow spending, thereby affecting the prices of goods and services and hence their relative prices.

Step by step solution

Define Monetary Policy

Monetary policy refers to the actions taken by a central bank or other monetary authority to manage the money supply and interest rates with the aim of achieving specific economic objectives such as controlling inflation, consumption, growth, and liquidity.

Define Relative Prices

Relative prices are the price of one good or service compared to the prices of other goods and services. They reveal the terms on which goods can be substituted for each other.

Connect Monetary Policy to Relative Prices

Monetary policy can affect relative prices in a number of ways. If a central bank changes the money supply, this will generally alter interest rates, which can influence spending decisions by businesses and households. Increased spending can drive up prices for certain goods or services more than others, leading to changes in relative prices.

Explain the viewpoint

Therefore, it can be agreed that monetary policy can affect relative prices. A monetary policy that increases the availability of money might stimulate spending and drive up the prices of those goods and services which are in high demand, thereby affecting their cost relative to other goods or services. Conversely, a contractionary monetary policy could suppress spending and result in an overall decrease in prices, again affecting relative prices.

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