3.5.6—Effectiveness of monetary policy

Monetary policy effectiveness depends on transmission strength, timing, credibility, financial conditions and the cause of the shock.

Liquidity traps, weak banks, high debt, supply shocks and uncertain expectations can weaken or reverse effects.

State the constraint and evidence before judging effectiveness.

Rate cuts may not raise spending if households are repairing debt and banks restrict lending.

A policy can be appropriate yet ineffective under current conditions.

Strengths include small incremental changes, flexibility, easy reversibility and relatively short decision/implementation lags. Constraints include little room to cut nominal rates near zero and weak consumer or business confidence that suppresses borrowing and spending. Transmission may also vary with debt, banks and exchange rates. Judge success separately for growth, unemployment and price stability: easing can be potent against weak AD with functioning credit, but less effective near zero or against cost-push inflation, where extra AD may worsen prices.