Introduction In this paper, I will explore the definition of monetary policy, the objectives of the monetary and the monetary policy bases. Definition of Monetary Policy Monetary policy consists of the actions of a central bank, currency board or other regulatory committee to control the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in the vault. The Federal Reserve is in charge of monetary policy in the United States. Types of Monetary Policy There are two types of monetary policy: expansionary and contractionary.
This results in banks lending out their excess reserves which in turn will increase the supply of money. On the other hand, when the Federal Reserve sells securities in the open market to commercial banks or to the public, bank reserves will be reduced and thus the nation’s money supply will decline (McConnell-Brue, 2004, chpt. 15). “The Fed can also manipulate the reserve ratio in order to influence the ability of commercial banks to lend” (McConnell-Brue, 2004, chpt. 15).
1. Introduction: Monetary policy is the procedure by which the monetary controller of a country, for example the central bank or currency board, controls the supply of money, frequently targeting an inflation rate or interest rate to assure price stability and complete trust in the currency. Additional aims of a monetary policy are commonly to give a share in economic growth and stability, to minor unemployment, and to preserve predictable rate of exchange with other currencies. Monetary economics offers insight into how to skill an optimal monetary policy. Since the 1970s, monetary policy has generally been made individually from financial policy, which attribute to the taxation and government spending.
With interest rates, this allows banks to take a percentage of the consumer’s money and loan it out to others, thus allowing economic growth to be possible. Interest rates also allow lenders to have a “safety net” which is necessary because there is a possibility that the borrower would be unable to pay back a loan to the bank. A nation’s interest rates can be raised or lowered and these shifts in interest rates correlate directly to aggregate demand. Aggregate demand, is the total demand for final goods and services in an economy at a given time (Business Dictionary). A nation uses interest rates for economic growth or to help prevent inflation.
Monetary Policy Monetary policy refers to use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit. The goal of monetary policy are achieving specific objectives, such as low and stable inflation and promoting growth. The monetary policy is that wing of economic policy that concern with cost and availability of money in economy is perhaps stating without being informative. In terms of public perception, the way fiscal policy is associated with taxation, monetary policy is perhaps mostly conceived of as interests rate is changes so that one gets more while depositing money in the local bank or pays more while taking a house lone. These actions mostly have to do with commercial banks
The Federal Reserve and Macroeconomic Factors Introduction The Federal Reserve controls the economy of the United States through a variety of tools. They use these tools to shape the monetary policy of the United States in order to promote economic growth and reduce the rate of inflation and the unemployment rate. By adjusting these tools, the Fed is able to control the amount of money in the supply. By controlling the amount of money, the Fed can affect the macro-economic indicators and steer the economy away from runaway inflation or a recession. The Federal Reserve The Federal Reserve uses three main tools in order to control the money supply.
This determines whether the base money that the Fed will release should decrease or increase. As stated in the simulation, the Fed also "tries to use the money supply as a lever to keep the economy on the rails". This is not an easy task for it requires very complicated analysis. Influence on Money Supply There are several factors affecting the money supply: spread between the discount rate and federal funds rate, required reserve ratio and open market operations. It is very important to understand that whenever the "DR charged by Fed is lower than the FFR charge by other banks; banks tend to borrow from the Fed.
Therefore an increase in the bank rate, indicating a tight monetary policy, would result in expectations that the bank rate will decrease in the future. This expectation results in a depreciation of currency. However, if the market expects the bank rate to further increase to lower domestic inflation, it would result in anticipation of future appreciation of the currency. This expectation results in appreciation of the currency. A Report of the Committee on Fuller Capital Account Convertibility accepted that volatility in exchange rate is caused due to flexible exchange rate policy, inflationary pressure and capital inflow.
As prevention the central bank must ease or tighten policy in order to accommodate these expectations. Due to the ability to make adjustments based on current happenings I believe that the Federal Reserve should operate under a discretionary policy. The expectations trap draws the central banks in to make a stronger commitment to price constancy. As an anchor for inflation, improvements in employment and economic growth can be seen. Stability of the real economy is also enhanced in the short run.
The Federal Discount Rate is an interest rate, so lowering it is essentially lowering interest rates. If the Federal Bank instead decides to lower reserve requirements, this will cause Banks to have an increase in the amount of money they can invest. This causes the price of investments such as bonds to rise, so interest rates must fall. No matter what tool the Fed uses to expand the money s... ... middle of paper ... ...lly and fewer domestic goods sold abroad, the balance of trade falls. As well, higher interest rates cause the cost of financing capital projects to be more, so capital investment will be less.