Interest Rate Targeting Monetary Policy

Topics: Central bank, Monetary policy, Inflation Pages: 18 (5778 words) Published: March 11, 2011
This paper attempts to discuss and examine the importance and impact of monetary policy which is being conducted by a central bank in the country. The analysis covers the target of monetary policy in Malaysia. It also compares two monetary policy (interbank interest rate) which was conducted by central bank of Malaysia and fed funds rate which was practiced by Federal Reserve Bank of New York. It concentrates further some factors that may have relation to changing in monetary policy. Base lending rate, BNM treasury bills and ringgit value against dolar are also highlighted in the discussions. This paper was done with help of our lecture by guiding and assisting how to get the genuine data. Besides, review of past study was done through our study. Bank Negara Malaysia was used as main source of term paper along with IIUM database and other online articles as well as other sources from U.S financial home pages. It concludes that the monetary policy is a vital to adopt by every nation to control financial activities and protect a country from financial panics any time at any point.

With necessity of controlling the financial system, nations have had established the central banks as a monetary authority to be in charge of managing financial activities. The operations and mechanisms may differ from one country to another but central banks have a common purpose which is to achieve financial stability and maintain an economic well-being. Monetary policy is defined as a process in which monetary authority controls the money supply that often aimed to target interest rate and other factors to obtain economic growth and financial stability in the country and avoid inflation and financial crisis as happened 1997 in Asia and 2007 in United States caused by sub-price mortgages. The understanding of monetary policy and how it affects the economic activities, money supply, and interest rates is crucial to those who deal with system. It has tools, goals and targets that can be used to prevent financial disorder or panic from the country. According to Umezaki (2006), Central banks in general evaluate the present state of the economy based on the available information at each point of time, and conduct monetary policy to achieve policy goals in the future. Available information includes, for example, monetary and economic statistics up to the previous month. If the available information indicates an inflationary pressure, the central bank would tighten its monetary policy by, for example, mopping up excess liquidity. However, it will take several months for this tight monetary policy to be reflected in the inflation rate. Therefore, it is reasonable to assume that a central bank conducts its monetary policy while taking the time lag into account.

Problem statement
With the rapid change of the market conditions from time to time and follow of funds as well as business cycle, the central banks have a responsibility to oversea and use suitable monetary tools to avoid imbalance. It is very interesting factor to know at this point which policy has a great deal and an impact on controlling money circulation, interest rates and price stability. Expansionary policy increases the total supply of money in the economy rapidly while contractionary policy decreases the total money supply.This paper examines three monetary policies namely; overnight policy (interbank interest rate) with parallel of base lending rate, exchange rate in the case of Malaysia and fed funds rate in the case of America. Objectives

This term paper discovers the difference between the fed funds rate which is an interest rate that banks charges each other for loans mostly overnight. It is used to influence the supply of money in U.S economy to make the federal funds effective rate follow the federal funds target rate. Besides, the base lending rate of Malaysia is also included to see how far relationship it has with interest rate. Among...

References: Mishkin (2009), Financial Market and Institutions, 6th edition, Pearson Prentice Hall, New York
Robert Neil, (2001) Understanding monetary policy in Malaysia and Thailand, (Bis papers no 31), Hong Kong Institute of Monetary Research.
Kurt Schuler (2007), Classifying Exchange Rates
Isabelle Bensidoun, Virginie Coudert, Laurence Nayman (1997), Interest Rates in East Asian Countries, CEPII
Javad Kashefi (2008), the Effect of Changes in the Federal Funds Rate, Euro Journals Publishing, Inc
Rajneesh Tiwari (2003), post-crisis exchange rate regimes in Southeast Asia, University of Hamburg.
Umezaki, (2006), Monetary and Exchange Rate Policy in Malaysia before the Asian Crisis, institute of developing economies, Japan,
Bank Negara Malaysia website (
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