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What are the basic objectives of monetary policy? Comment on the cause-effect chain through which monetary policy is made effective. What are the major strengths of monetary policy?
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In this week’s lesson we learned about monetary policy and its objective. According to the lesson, the object of monetary policy is to help promote goals of economic growth, full employment, and price stability by influencing interest rates, the supply of money and credit. The goal is to keep the economy humming along at a rate that is neither too hot nor too cold (Investopedia, 2021). There are two types of monetary policies: expansionary monetary policy and contractionary monetary policy. Expansionary monetary policy is aimed at increasing economic growth when faced with high unemployment due to a recession. Contractionary monetary policy increases interest rates in order to reduce inflation. Prior to this week’s lesson, I had very little knowledge on this subject so I will try my best to explain the cause-effect chain. A change in the money supply affects interest rates. This affects spending which ultimately affects demand. Changes in demand affect employment and the price level. At this point, the Fed must decide on the appropriate action in order to balance the economic growth. Monetary policy aims to keep unemployment low, protect the value of the currency, and maintain economic growth at a steady pace (Investopedia, 2021). One of its many strengths, and perhaps the most important, in my opinion, is its flexibility. Fiscal policy is enacted by the national government by spending taxpayer dollars whereas monetary policy is enacted by the central bank. This gives it more flexibility to either raise or lower interest rates or the money supply.Reference:Investopedia Team. (2021, August 29). What is monetary policy? Investopedia. Retrieved October 14, 2021, from https://www.investopedia.com/terms/m/monetarypolicy.asp.-Romny
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The basic objectives of monetary policy as stated in the weekly content are to continue economic growth in the economy, reach full employment, and reinforce price stability by affecting interest rates and supply of money and credit. In my opinion I feel the cause-effect chain which prompts monetary policy is straight forward. From a neutral position, when the economy is healthy, GDP, aggregate demand and supply are in a fine balance then there is not much need for monetary policy because the economy is stable or self-sufficient. However, if the economy starts to decline, and GDP falls then expansionary monetary policy may be implemented. Ultimately the goal will be to stimulate the economy again by introducing more money into circulation. Some methods of getting the economy back on track based off the weekly content would be would be the fed buying government securities from banks, lowering the legal reserve ratio and reduction in the discount rate. This causes the money supply to rise, interest rates to fall, and slowly but surely the GDP starts to increase again. The opposite happens to battle things like inflation. The fed can sell securities and increase discount rates which will reduce money supply causing banks to be more restrictive with their loans. Furthermore, interest rates will rise and money supply will decrease. Once interest rates rise, consumers will be less likely to make investments which will have compounding effects on aggregate demand, driving inflation down. The major strengths of monetary policy are apparent. Central banks and the fed have the ability to manipulate the economy via monetary policy to achieve their goal, be it to reduce inflation through increasing interest rates and reduce overall money supply or stimulate the economy and create money supply. Lastly, monetary policy is not a new concept and is refined to a point where many economic scenarios could not be remedied. Having the flexibility to implement monetary policy is a critical capability that can help with the stabilization of the economy in times of crisis such as before, during, or after a war or during a recession or pandemic that causes significant effects to the economy.less
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