Question

Part II: Analyze what 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 the possibility of a liquidity trap significant to policymakers?

Answer 1

Answer:

Cyclical asymmetry refers to the condition that a restrictive monetary policy is relatively potent at contracting economic activity, while an expansionary monetary policy is relatively weak at stimulating an economy. The weakness in expansionary monetary policy 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 the 1990s, expansionary monetary policy may be inadequate, and an expansionary fiscal policy may be necessary to stimulate recovery