Monetary Policy Transmission in Recession

Steps:

• Expansionary monetary policy increases money supply, lowering interest rates to boost investment and depreciating the currency to enhance exports.
• Effectiveness requires room to cut rates (high current nominal rates) and a beneficial depreciation (current appreciating exchange rate).
• In recession, low demand and spare capacity amplify policy impact without inflationary pressures.
• Eliminate options where barriers like low rates, full capacity, or external shocks hinder transmission.

Why B is correct:

• High nominal rates allow significant cuts per the interest rate channel; appreciating exchange rate enables depreciation to stimulate net exports via the exchange rate channel.

Why the others are wrong:

• A: Global financial crisis impairs credit transmission, reducing policy effectiveness despite depreciation.
• C: Inflation above target signals overheating, not recession, limiting expansionary policy scope.
• D: Low nominal rates hit zero lower bound (liquidity trap); no spare capacity risks inflation without output gains.

Final answer: B