Keynes and animal spirits: savers and the wealth effect

1) As of the Spring of 2011 interest rates are near 0% and have been for sometime.

a) According to theory, if you lower interest rates, business investments and consumer purchases of large durable goods are supposed to increase. In return, this is to help pull us out of a recession. However, this policy of extraordinarily low interest rates has not stimulated investment demand. Why do you think this is the case (hint – think Keynes and animal spirits).

b) How might this policy be exasperating the recession (hint – think of savers and the wealth effect)

c) A colleague of mine said that ‘monetary policy does nothing but create bubbles in the economy’. Do you agree with this statement? How did the low interest rate environment of the ‘post dot com’ bubble day help to contribute to the housing bubble? Do you forsee another market bubble in the economy (ie, in the housing market or stock market or in ‘gold stocks’ – explain relating low interest rates to a new bubble).

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