What is Recessionary Bias

To illustrate the possibility of recessionary bias we assume that both countries have two policy objectives but only one policy instrument. The policy objectives are assumed to relate to an optimal level of national income, and an optimal balance of payments surplus. This second objective assumes that for some reason both countries seek to accumulate foreign currency reserves, at least in the short run. The policy instrument is again assumed to be monetary policy, specifically related to the growth rate of the domestic money supply. Figure below shows the Hamada diagram derived under these assumptions.