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Upon viewing the simulation, we gather that the monetary policy is not effective since the demand for loans is shrinking, although it is at a low interest rate. Much like Japan¡¦s recession in the 90¡¦s, there is too much money in the market. Demands for investment is low and therefore demands for loans decrease as well. The recession in Japan was a prime example of a non-stimulated market when investors were unwilling to borrow even though interest rates were at 0%. Lowered interest rate will not recover the economy. If this situation prolongs, a wave of panic through the population will ensue and deflation may occur since the public is consuming, rather than spending.
The ultimate risk of slowing inflation is that it may cause a recession. Slowing inflation also causes unemployment to rise, GDP and interest rates to drop proportionally to inflation, and the reserve ratio to increase. The increase in reserve ratio will cause less return for lenders.
To mitigate these risks, interest rates must decrease in order to stimulate investment and for consumers to put their money in the market. By having an influx of investment in the economy, more jobs will be created, thus decreasing the unemployment rate.
Deflation must be avoided at all costs because redistribution of income is not balanced. There is very little money circulating the market and the price of utility is not stable. Commodities are dropping in prices. Like the Japanese example above, an economy suffering from prolonged recession is very difficult to recover. Implementation of necessary monetary policies to bring the economy back to normal levels is important. ...