Question

Discuss how monetary policy (e.g. stimulative or restrictive policy) affects the short-term and long-term rates, respectively, and thus the yield curves.

Answer 1

The goal of monetary policy is to help the economy reach or maintain monetary equilibrium. An economy is at monetary equilibrium when the quantity of money demanded equals the quantity of money supplied. Through monetary policy, the federal bank use to increase or decrease the federal funds rate so that they can control the money circulation in the economy. Generally at the time of recession, they use to lower the fund’s rate to increase the money circulation (stimulative policy). By increased money circulation with lower rates increases the purchasing power of the consumers in the economy and helps the economy to recover from the recession in faster manner. Similarly at the time of boom they use to increase the fund’s rate to reduce the money circulation in the economy (restrictive policy). This way monetary policy affects the short-term as well as long-term rates and the yield curves.