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Answer: The risk of inflation outweighs the risk of deflation, making monetary policy more impactful.
Monetary policy is most effective when the risk of inflation is greater than deflation. Deflation, a persistent decline in general price levels, poses significant challenges for central banks, as conventional tools like lowering nominal interest rates below zero are difficult to implement. In contrast, inflation can be managed more effectively with monetary policy. A liquidity trap (Option A) renders monetary policy ineffective, while exchange rate targeting (Option B) introduces volatility in domestic conditions.
Author: LeetQuiz Editorial Team
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Under which of the following conditions is monetary policy most effective?
A
The demand for money is infinitely elastic, leading to a liquidity trap.
B
The central bank targets an exchange rate, causing volatility in domestic interest rates.
C
The risk of inflation outweighs the risk of deflation, making monetary policy more impactful.
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