Introduction to Monetary Policy
Monetary policy is a set of tools built with the intention of promoting sustainable economic growth.
A country’s central bank promotes these tools by controlling the overall supply of money that is available at the nation’s banks, its consumers, and its businesses.
The sole intention of a monetary policy is to keep the economy pulsing along at a rate that is consistent.
To discourage spending the central bank may force up interest rates on borrowing or to inspire more borrowing and spending they may force down the interest rates.
The central bank uses the nation’s money for playing with the rates. The rates it charges to loan money to the nation’s banks are set by the central bank.
All financial institutions adjust the rates to their customers right from the big businesses who are borrowing for major projects or home buyers applying for mortgages are charged according to the rise and drop of the central bank.
Ideally, customers are more likely to borrow when rates are low and avoid borrowing when the rates are high.
Understanding Monetary Policy
The control of the quantity of money available in an economy and the channels by which new money is supplied is what is monetary policy.
By managing the money supply, a central bank aims to influence macroeconomic factors like economic growth, inflation, the rate of consumption, and overall liquidity.
Along with modifying the interest rate, the central bank also buys or sells government controls foreign exchange rates, and amend the amount of cash that the banks need to maintain as reserves.
Monetary policy decisions and the minutes of meetings in which they are discussed are eagerly awaited by economists, analysts, and investors.
Because it has a long-lasting impact on the overall economy and on specific industry sectors and markets.
How is the Monetary Policy Decision Analyzed?
Inputs from a variety of sources formulate the monetary policy. The monetary authority may look at macroeconomic numbers like inflation and gross domestic product (GDP), industry and sector-specific growth rates, and associated figures.
It monitors geopolitical developments. Actions that may have a far-reaching impact are oil embargos or the lifting/imposition of trade tariffs.
Concerns raised by groups that represent specific industries and businesses, private organizations’ survey results, and inputs from other government agencies are also considered by the central bank.
The mandate of Monetary Policy
To achieve a stable rise in the GDP, to maintain a low level of unemployment, and maintain foreign exchange and inflation rates in a predictable range the monetary authorities are given broad policy mandates.
The Federal Reserve Bank is in charge of monetary policy and they have a dual mandate — while keeping inflation in check and achieving maximum employment.
So it is the Fed’s responsibility to balance economic growth and inflation. They also should aim to keep long-term interest rates relatively low.
The Different Types of Monetary Policies
Monetary policies are either expansionary or contractionary
I — Expansionary Monetary Policy:
If due to a slowdown or a recession a country is facing high unemployment, the monetary authority can opt for an expansionary policy to increase economic growth and expand economic activity.
During the expansionary policy, the monetary authority lowers the interest rates and promotes spending money.
This increased supply of money in the market boosts investment and consumer spending.
When the interest rates are lower it means that businesses and individuals can get loans on favorable terms.
This expansionary approach where the interest rates are near zero has been held by many leading economies around the world since the global financial crisis.
II — Contractionary Monetary Policy:
For the purpose of slowing the growth of the money supply and bringing down inflation the contractionary monetary policy increases interest rates.
It slows the economic growth and increases unemployment but it is also necessary to cool down the economy and keep prices in check.
Different Tools to implement Monetary Policy
A number of tools are used by central banks to shape and implement monetary policy.
Open market operations — first it buys and sells short-term bonds on the open market by using newly created bank reserves.
It targets short-term interest rates like the federal funds rate, where money is added into the banking system by buying assets or removed by selling assets by the central bank.
The banks respond by loaning the money more easily at lower rates or at higher rates till they meet the central bank’s interest rate target.
The second option is the discount rate. The reserve requirements are manipulated by authorities. These funds are retained by banks as a proportion of the deposits made by their customers to ensure that they are able to meet their liabilities.
By lowering this reserve requirement more capital is released for the banks to offer loans or to buy other assets.
The Difference Between Monetary Policy vs Fiscal Policy
Monetary policy is approved by a central bank with the intention to keep the economy on an even keel.
The goal is to protect the value of the currency, keep unemployment low, and maintain economic growth at a steady pace.
This is achieved by influencing interest rates so that it raises or lowers borrowing, spending, and savings rates.
The national government enacts fiscal policy. For the purpose of stimulating economic recovery, a fiscal policy involves spending taxpayer dollars. To increase spending and enhance growth it sends money, directly or indirectly.
What is the Frequency at which the Monetary Policy Changes?
The Federal Reserve’s Federal Open Market Committee meets eight times a year. After a few days of discussion, it announces if any change will be made to the nation’s monetary policies, and, if so, what they will be.
Conclusion
A set of actions that can be undertaken by a nation’s central bank in order to control the overall money supply and achieve sustainable economic growth is known as monetary policy.
Expansionary or contractionary are the two classifications of monetary policy.
Some tools of monetary policy are revising the interest rates up or down, changing bank reserve requirements, and direct lending cash to banks.
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