Though Monetary Policy
is said to be a tool to control demand during high inflation and full
employment, but it also decreases supply due to higher borrowing cost lower
investment and higher unemployment which reduce supply.
During high inflation
it is best to cut rates to increase supply due to higher prices which would
contain demand and prices. For businesses higher prices, lower interest rates
are good for investment and increase employment and profits.
If we have reached full
employment higher wages would help contain employment and demand and a zero
interest rate would help increase investment and supply and growth.
Demand and supply are
different names of the economic activity when both increase prices, interest
rate and wages increase and when both fall prices, wages and interest rate
fall.
Laissez faire or free
market or the invisible hand philosophy or ideology is true in the long run,
few years, even Keynes proposed government intervention to increase employment
during underinvestment by the private sector, lower prices, wages and interest
rate and liquidity trap in which interest rate cannot go below zero.
In this situation
inflation could lower real interest rate but would also reduce real wages and
demand which together means lower demand and inflation further, however lower
prices due to zero interest rate would help increase employment and demand and
investment and supply and inflation faster, Pigou. Public investment/employment
might help recover fast.
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