Monetary Policy of a Central Banking System

I. INTRODUCTION

Monetary Policy is how the Central Bank influences the path it wants the economy to follow. It does this through the control of money supply using the short term interest rate as the primary instrument to control inflation and economic growth.

The objectives of most Central banks is to sustain low unemployment and relatively stable prices however price stability is the main, medium and longer run goal of monetary policy. An expansionary monetary policy is targeted at increasing the money supply through lowering interest rates with the hope of increasing consumption and investment through easing credit; it is used to combat unemployment in periods of recession. A contractionary policy however is used to decrease money supply by increasing the interest rate; it is intended to slow down inflation.

Monetary policy has been an area with lots of economic research in several countries with the focus being on the empirical analysis of monetary policy shock on output and prices. Econometric models have been used to determine the effects of different policy options. With time, econometric analysis techniques have improved and most recent literatures have estimated the effects of monetary policy using VAR and SVAR techniques, this has allowed the evaluation of the effectiveness of monetary policy in several countries.

In the actual, shocks in the economy are driven by developments beyond the central bank. Studies on monetary policy have exhibited a large variance in results amongst different countries primarily resulting from the different business cycles experienced at different times between countries; output and prices appear to be strong or weak depending on sample periods

The objective of this study is to examine th...

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