In our various writings, we have suggested that loose monetary policy of the central bank, which amounts to the lowering of interest rates and monetary pumping, gives rise to activities that cannot exist by themselves without the support from this loose monetary policy.
An increase in money supply as a result of an easy monetary stance by the central bank sets an exchange of nothing for something i.e. the diversion of real wealth from wealth generators towards activities that emerge on the back of loose monetary policy. We label various activities that emerge on the back of loose monetary policy as bubble activities. Given that these activities cannot support themselves, they constitute a burden on wealth generators.
It is tempting to suggest that a tighter monetary stance of the central bank could undo the negatives of the previous loose monetary stance i.e. inflationary policy through the removal of bubble activities. In fact, this type of policies carries a label of countercyclical policies.
On this way of thinking, whenever economic activity slows down it should be the duty of the central bank to give it a push, which will place the economy back on the trajectory of an expanding economic growth. The push is done by means of loose monetary policy i.e. the lowering of interest rates and raising the growth rate of money supply.
Conversely, when economic activity is perceived to be “too strong”, then in order to prevent an “overheating” it should be the duty of the central bank to “cool off” economic activity by a tighter monetary stance.
This amounts to raising interest rates and slowing down monetary injections. It is believed that a tighter stance will place the economy on a trajectory of stable non-inflationary growth. On this way of thinking, the economy is perceived to be like a space ship, which occasionally slips from the trajectory of stable economic growth.
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