monetary policy

Examples of monetary policy in the following topics:

• The Effect of Restrictive Monetary Policy

  • A restrictive monetary policy will generally increase unemployment and decrease inflation.
  • Monetary policy is can be classified as expansionary or restrictive (also called contractionary).
  • Restrictive monetary policy expands the money supply more slowly than usual or even shrinks it, while and expansionary policy increases the money supply.
  • Monetary policy focuses on the first two elements.
  • A central bank can enact a contractionary monetary policy several ways.

• Introduction to Monetary Policy

  • Monetary policy is the process by which a monetary authority controls the money supply, often to produce stable prices and low unemployment.
  • Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing.
  • A monetary authority will typically pursue expansionary monetary policy when there is an output gap - that is, a country is producing output at a lower level than its potential output.
  • By contrast, a monetary authority will pursue a contractionary monetary policy when it considers inflation a threat.
  • Thus, contractionary monetary policy causes aggregate demand to fall, thereby reducing the rate of inflation. .

• The Effect of Expansionary Monetary Policy

  • Monetary policy is referred to as either being expansionary or contractionary.
  • Monetary policy focuses on the first two elements.
  • A central bank can enact an expansionary monetary policy several ways.
  • Another way to enact an expansionary monetary policy is to increase the amount of discount window lending.
  • Another method of enacting a expansionary monetary policy is by decreasing the reserve requirement.

• Arguments For and Against Fighting Recession with Expansionary Monetary Policy

  • Expansionary monetary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates.
  • Monetary policy, to a great extent, is the management of expectations between interest rates, the price of the use of money, and the total supply of money.
  • When the central bank is in complete control of the money supply, the monetary authority has the ability to alter the money supply and influence the interest rate to achieve policy goals .
  • The increase in the money supply is the primary conduit for expansionary monetary policy.
  • Assess the value of discretionary expansionary monetary policy and the associated shortcomings.

• Arguments For and Against Discretionary Monetary Policy

  • These typically used fiscal and monetary policy to adjust inflation, output, and unemployment.
  • Policy is implemented based on indicator events in the economy and the policy is expected and carried out in a timely manner.
  • In this case the central banking authorities have autonomy and are able to use monetary policy to enable their mandate of economic growth and full employment.
  • The policies they enact cannot be destabilized by government fiscal policy.
  • Milton Friedman was a Nobel Prize (1976) recipient in the field of Economics and was a supporter of rules-based monetary policy.

• Limitations of Monetary Policy

  • Monetary policy can influence an economy but it cannot control it directly.
  • There are limits as to what monetary policy can accomplish.
  • Below are some of the factors that can make monetary policy less effective.
  • This is an especially significant problem when fiscal policy and monetary policy are controlled by two different parties.
  • If monetary policy is too contractionary for too long, deflation could set in.

• Monetary Policy and Fiscal Stabilization

  • But with inflation increasingly ravaging the economy, the central bank abruptly tightened monetary policy beginning in 1979.
  • The growing importance of monetary policy and the diminishing role played by fiscal policy in economic stabilization efforts may reflect both political and economic realities.
  • Political realities, in short, may favor a bigger role for monetary policy during times of inflation.
  • One other reason suggests why fiscal policy may be more suited to fighting unemployment, while monetary policy may be more effective in fighting inflation.
  • The monetary policy remedy to economic decline is to increase the amount of money in circulation, thereby cutting interest rates.

• Managing the Business Cycle

  • When the economy is not at a steady state, the government and monetary authorities have policy mechanisms to move the economy back to consistent growth.
  • When the economy is not at a steady state and instead is at a point of either overheating (growing to fast) or slowing, the government and monetary authorities have policy mechanisms, fiscal and monetary, respectively, at their disposal to help move the economy back to a steady state growth trajectory.
  • Expansionary monetary policy relies on the central bank increasing availability of loanable funds through three mechanisms: open market operations, discount rate, and the reserve ratio.
  • Similarly, contractionary monetary policy is the opposite of expansionary monetary policy and occurs when the supply of loanable funds is limited, to reduce the access and availability to relatively inexpensive credit.
  • Identify how changes in monetary and fiscal policy can manage the business cycle, and why that is desirable

• Using Monetary Policy to Target Inflation

  • Inflation targeting occurs when a central bank attempts to steer inflation towards a set number using monetary tools.
  • Inflation targeting is an economic policy in which a central bank estimates and makes public a projected, or "target", inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools .
  • Under the policy, investors know what the central bank considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment choices.
  • The United States Federal Reserve uses a form of inflation targeting when coordinating its monetary policy.
  • Assess the use of inflation targets and goals in monetary policy

• Limits of Fiscal Policy

  • Two key limits of fiscal policy are coordination with the nation's monetary policy and differing political viewpoints.
  • Fiscal policy and monetary policy are the two primary tools used by the State to achieve its macroeconomic objectives.
  • While the main objective of fiscal policy is to influence the aggregate output of the economy, the main objective of the monetary policies is to control the interest and inflation rates.
  • For example: if the fiscal authority raises taxes or cuts spending, then the monetary authority reacts to it by lowering the policy rates and vice versa.
  • Also, it is worthy to note that fiscal and monetary policies interact only to the extent of influencing the final objective.