Question

It is often reported by financial news reports that higher interest rates reduce automobile sales. If this is true, we can expect

	a.	fiscal policy to be more effective.
	b.	both fiscal and monetary policy to be more effective.
	c.	monetary policy to be more effective.
	d.	neither fiscal nor monetary policy to be more effective.

Answer 1

It is often reported by financial news reports that higher interest rates reduce automobile sales. If this is true, we can expect monetary policy to be more effective (Option C). Monetary policies deal with management of money supply and central bank's determination of interest rates. To give pace to a faltering economy, the central bank usually cuts interest rates, thus making borrowing less expensive while increasing the money supply. On the other hand, if there is rapid growth in the economy, the central bank uses contractionary monetary policy by increasing interest rates and decreasing money supply. To combat inflation when the economy is growing rapidly, central bank uses contractionary monetary policy which tightens the money supply and increases interest rates. This impacts exports, imports, business expansion and the relative cost of consumption compared to saving. Tus, aggregate demand reduces. So, we can say that if higher interest rates are reducing automobile sales, then the monetary policy is effective.