Impact on Output:

Once the money supply is altered the interest rate undergoes change. With the interest rate changes the level of investment in the economy undergoes changes. If the rate of interest falls then more investment projects becomes profitable, housing market tends to get a push and the consumer spending of durables (which toady is largely based on credit) tends to go up too. Also the stock markets tend to look up as well. So, on the whole the economy's growth tends to pick up. This policy of expansionary monetary policy as one will expect is adopted in the times of ensuing recession by the central bank in many economies across the world. In recent times, central banks of the US, India, European Union have used this policy to pop up their economies. Japan has been experiencing recession since the early 1990s and the policy of lowering the interest seems to have backfired. What has gone wrong in Japan?

According to Keynesian perspective, money demand becomes perfectly elastic at very low rates of interest. Keynes referred to this phenomenon as the 'liquidity trap'. At very low rates of interest the speculative demand for money becomes infinite. That means the people in the economy hold on to cash as they believe that the interest rate is so low that it can move in only one direction that is up. The rate of interest in Japan has been close to zero from past few years. So the expansionary monetary policy being followed by Bank of Japan has been ineffective as the interest rate cannot fall below zero. So the demand boosting effect of monetary policy did not happen and the recession lasted much longer for the Japanese economy.

It is only in last few quarters that the situations seems to have improved as the Bank of Japan has started changing the course of its monetary policy. The expansionary monetary policy is followed along with the fiscal policy whenever the recessionary pressures build up in an economy. If one examines the recent experience of India, Europe and the US one could observe that these countries have used the policy of monetary and fiscal stimulus to pop up their economies. The central banks across these  economies reduced interest rate (which is nothing but an expansionary monetary policy) to take economy out of recession. In last five years since 2001 he world economy has been growing at very fast pace. The fall in the interest rate as mentioned earlier  boosts consumer spending, as well investment demand besides pushing the housing and stock market. This has helped the world economy to come out of recession reducing significantly the volatility which could result from the usual business cycles.