Is Monetary Policy Too Tight?

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Abstract
Monetary policy has steadily become tighter over the past twelve months. In various statements, the Government has indicated its view that monetary policy needs to be tight in order to subdue an ‘excessively high’ rate of growth of domestic demand. This article asks whether the current stance of monetary policy is now too restrictive and, if so, what the consequences might be for the pattern and growth of economic activity during 1989‐90. A number of scenarios based on alternative settings of monetary policy in 1989‐90 are derived from a short‐term simulation model of the Australian economy. The scenarios suggest that, if monetary policy remains at the current degree of tightness, the Australian economy may well experience a recession in 1989‐90. Some easing of monetary conditions is mandatory if a sharp and unnecessary slowdown of economic activity is to be avoided. Exactly how far monetary policy should be eased depends crucially on the rate of growth of autonomous investment.

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