Question

When the Fed increases the money supply through open market operations, it can take some time before the interest rate changes and new investment happens. • Is this an example of inside or outside lag? • Why does doesn't the monetary expansion change GDP instantly? Provide an example relating to either the bank, the borrower, or another party in the economy.

Answer 1

Ans -: When Fed increases the money supply through OMO's ,it takes some time for new investment to happen .

This is an example of Outside Lag. [It is the time taken by a govt's action to reach the general public and show noticeable change] .

• Any Monetary expansion doesn't show effects immediately and always affect the GDP by some lag because the effects of monetary expansion depend on variety of factors such as consumer spending , leakages and savings in the economy , consumer expectations and confidence index , time taken by commercial banks to extend the benefit etc.

Example -: Suppose the  Federal Bank has done monetary expansion by decreasing the interest rates for loans or reserve requirements . This decreases the cost for commercial banks to extend loans to genetral public . But they do not extend the benefit to general public immediately rather they decrease their interest rates in parts. Also money given to the public might be saved for future use instead of spending it.

Now such a situation can delay the effects of monetary expansion because there is delivery lag .