Friday, July 19, 2024

Monetary Policy

In this article, We learn about “Monetary Policy “.Let’s Go!

Monetary policy refers to the actions taken by a country’s central bank to influence the supply and cost of money and credit to promote the health of the economy.

Monetary policy can be broadly classified as expansionary or contractionary .

Monetary policy includes the management of money supply and interest rates, aiming to achieve macroeconomic goals such as controlling inflation, consumption, growth and liquidity.

These can be accomplished through actions such as modifying interest rates, buying and selling government bonds, adjusting foreign exchange rates, and changing the amount of reserves banks are required to maintain.

Monetary policy tools include open market operations, direct bank lending, bank reserve requirements, extraordinary emergency lending programs, and managing market expectations (depending on the credibility of the central bank).

Monetary authorities are typically given a policy mandate to achieve stable gross domestic product (GDP) growth, maintain low unemployment, and keep foreign exchange rates and inflation within predictable limits .

Monetary policy can be used in conjunction with or as an alternative to fiscal policy, which uses taxes, government borrowing, and spending to manage the economy.

In the United States, the Federal Reserve sets monetary policy.

It attempts to ensure that the money supply grows neither too fast, causing excessive inflation, nor too slowly, hindering economic growth.

Ideally, inflation is about 2% per year, which keeps prices stable. The Fed is also working to keep the unemployment rate low, below 5%.

Its main tools that influence the money supply are forward guidance, discount rate , reserve ratio , open market operations, and large Credit Scale Asset Purchase (LSAP)

Almost all monetary policy is now implemented through open market operations, including the buying and selling of government bonds in the secondary market.

Through open market operations (expanding or contracting the money supply), central banks can effectively set short-term interest rates, which have long been regarded as the main tool of modern monetary policy.

After the financial crisis, the Fed also attempted to influence long-term interest rates by purchasing a range of longer-term instruments, such as mortgage-backed securities, through a policy known as “QE,” or quantitative easing.

What is the goal of the central bank’s monetary policy?

Central bank governors usually have many goals when implementing monetary policy:

  • They want to keep economic growth at the highest sustainable level
  • They want to keep unemployment at an absolute minimum.
  • They seek to keep inflation low.
  • They want to keep interest rates at reasonable levels (so as not to discourage investment)
  • Their goal is to keep the exchange rate stable.
  • They promote the stability of the financial system and seek to minimize systemic risk

Although ideally central bankers would like to achieve all of these goals simultaneously, there is now broad consensus that the primary goal must be stabilizing the price level.

One strategy for achieving this is inflation targeting, which requires the central bank to raise interest rates (by slowing money growth) when inflation begins to rise above a target level (e.g. 2%), and when inflation When inflation threatens to fall below target, they lower interest rates (by accelerating money growth).

Financial Stability

In recent years, central banks are reconsidering their role in promoting financial stability

Should financial stability be an explicit central bank goal on par with other goals such as price stability and sustainable economic growth?

Financial stability is defined as “the condition under which the financial system is able to withstand shocks without succumbing to accumulation processes that impair the allocation of savings to investment opportunities and the processing of payments in the economy”.

Financial instability is a situation with the following three basic criteria:

  1. Some important financial asset prices appear to deviate significantly from fundamentals; and/or
  2. The functioning of domestic and even international markets and the availability of credit have been severely distorted; as a result
  3. Total spending deviates (or is likely to deviate) significantly from the economy’s productive capacity, whether above or below it.

The Federal Reserve established the Financial Stability Division to identify and analyze potential threats to financial stability; monitor financial markets, institutions, and structures; and evaluate and recommend policy alternatives to address these threats.

If you want to learn more foreign exchange trading knowledge, please click: Trading Education.

Read more

Local News