What do economists mean when they say that monetary policy can exhibit cyclical

Question

What do economists mean when they say that monetary policy can exhibit cyclical asymmetry? How does the idea of a liquidity trap relate to cyclical asymmetry? Why is this possibility of a liquidity trap significant to policymakers?

5.   Suppose the government misjudges the natural rate of unemployment to be much lower than it actually is, and thus undertakes expansionary fiscal and monetary policies to try to achieve the lower rate. Use the concept of the short-run Phillips Curve to explain why these policies might at first succeed. Use the concept of the long-run Phillips Curve to explain the long-run outcome of these policies.

6.   What is the Laffer curve, and how does it relate to supply-side economics? Why is determining the economy’s location on the curve so important in assessing tax policy?

Explanation / Answer

Answers.

4.) Cyclical asymmetry refers to the condition that a restrictive monetary policy is relatively potent at contracting economic activity, while an expansionary monetary policyis relatively weak at stimulating an economy.The weakness in expansionary monetarypolicy results when, even though the Fed increases liquidity (reserves) in the system,potential borrowers are unwilling to spend (often because of uncertainty over general weakness in the economy). This is often referred to as a liquidity trap. Cyclical asymmetry, and the potential for a liquidity trap, is important to policymakers because it suggests that while monetary policy can effectively fight inflation, it may not be as successful in bringing an economy out of a recession.As Japan learned in the1990s, expansionary monetary policy may be inadequate, and an expansionary fiscal policy may be necessary to stimulate recovery

5.) in the short run there is probably a trade off between unemployment and inflation. the government's expansionary policy should reduce unemployment as aggregate demand increases. however, the government has misjudged natural rate and will continue its expansionary policy beyond the point of the natural level of unemployment As aggregate demand continues to rise, prices begin to rise. In the long-run, workers demand higher wages to compensate for these higher prices. Aggregate supply will decrease (shift leftward) toward the natural rate of unemployment.

In other words, any reduction of unemployment below the natural rate is only temporary and involves a short-run rise in inflation. This, in turn, causes long-run costs to rise and a decrease in aggregate supply. The end result should be an equilibrium at the natural rate of unemployment and a higher price level than the beginning level. The long-run Phillips curve is thus a vertical line connecting the price levels possible at the natural rate of unemployment found on the horizontal axis.  

6.) Economist Arthur Laffer observed that tax revenues would obviously be zero when the tax rate was either at 0% or 100%. In between these two extremes would have to be an optimal rate where aggregate output and income produced the maximum tax revenues.The difficult decision involves the analysis to determine what is the optimum tax rate for producing maximum tax revenue and the related maximum economic output level. Laffer argued that low tax rates would actually increase revenues because low rates improved productivity, saving and investment incentives. The expansion in output and employment and thus, revenue, would more than compensate for the lower rates.

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