Now let us understand the following with the help of above graph:

• AD_F = AD at full employment
• AD_A = Actual AD at more than full employment level
• AD_P = AD as planned
• ON = Full employment equilibrium GDP
• F = Point of full employment equilibrium
• EF = ‘Excess Demand’ or ‘Inflationary Gap’. This is the vertical difference between AD_P and AD_F

I hope if you go through above carefully, you will be able to answer it easily. Now let us come to next sub-question:

About Question b:

In the beginning, you must understand that monetary policy includes adjustment or chages in the following:

• Legal reserve ratio (such as CRR - Cash reserve ratio)
• Repo and Reverse repo interest rates
• Bank rate
• Statutory Liquidity ratio
• Open market operations

It is true that monetary policy matters a lot to the investors in a country. Investors are the quickest ones to respond to the change in market interest rates, which are really an outcome of monetary policy changes made by the central bank.

Now, we must take care the monetary policy, however important it be, is not the only factor that make the investors change their decisions. There is another which is of even greater importance - that is the Fiscal Policy driven by the government of a country (not by central bank, as was in the case of monetary policy). Fiscal policy chiefly comprises (i) Public spending by government; and (ii) Taxation policy.

It is actually the fiscal policy and monetary policy combined that drives the investors' sentiments. We can say that monetary policy has short-term implications whereas fiscal policy is relatively long-term implications on the investors' choices.

I hope you got it well too. Now, let me come to the last part.


About question c:

The question was "Is money targeting a better tool for central banks to use in the highly recessionary COVID-19 period where inflation has essentially disappeared as a policy issue?"

Well this could be debatable, but in the present situations which are recessionary due to COVID-19, we do see that in many economies around the world, tackling inflation has not remained a question. Rather those are facing deflation caused by lack of demand, to say - Recession.

Money targeting, in my view, is an effective way of reviving an economy. According to this idea:

• The central bank of an economy tries to increase the money supply (through M1 and M3 measures of money supply) and also
• Increase the circulation of money in the economy by way of adjusting the key interest rates.

Putting simply, in money targeting, the cental bank does not set targets for inflation control. It rather focuses upon (i) supply; and (ii) circulation of money in the economy.