Monetary policy

Topics: Monetary policy, Central bank, Inflation Pages: 6 (2171 words) Published: January 6, 2014
It has become a global world after Bretteon Woods Agreements, since then, international trading has become increasingly important for a country’s economic. The force of macroeconomic environment such as exchange rate and interest rate can impact on the competitiveness of business trading overseas. Moreover, the economic environment of booming and recession can affect the profitable of a country. The evidence demonstrated that it is crucial important for a country to understand the forces that affect the performance the economic and the interrelationship with foreign countries.

This essay will analyze how loose monetary policy has responded to exchange rate movements in open economies, paying particular attention to US and Japan on their quantitative easing program. First of all, it will define the monetary policy and explain the techniques using it. After that, the relationship between expansionary policy and exchange will be addressed and shown by the diagrams. Finally, the new currency war and disadvantages will be put forward.

Monetary Policy Operation
Monetary policy is the movement of a central bank, currency board or other regulatory committee that determine the economic target and use techniques to control the monetary supply and interest rate (Harry G. Johnson). For instance, The Bank of England’s Monetary Policy Committee (MPC) meets every month to set the interest rate . As same as UK, the European Central Bank (ECB) sets the interest rate for Euro zone countries and Federal Reserve Bank (FRB) sets US interest rates .

Tools of Monetary Policy
Discount Rate is the rate of interest that has been charged to commercial bank and other financial intermediaries on loans and advances . Lower interest rate can increase money supply and boost economic activities. Statutory Liquidity Ratio is the amount of liquid assets that financial institution must maintain as reserve. Reserve requirement is the minimum ratio of customer deposit and notes that every commercial bank should hold and reserve. Open Market Operations is an activity that government sell (or buy) government bond on the open market to control the total money supply. It has been seen as a way of achieving monetary targets. Expansionary Monetary Policy and Tight Monetary Policy

These four basic tools can combine into two general types of monetary policy: expansionary monetary policy and tight monetary policy. Expansionary monetary policy, as known as loose monetary policy, is “a policy by monetary authorities in order to expand money supply and boost economic activities”. It will increase the money supply, shift Sm out to Sm1 and drop the interest rate to ir1 (Figure1). It is mainly encouraging people to spend by keeping interest rate low through purchase securities on the open market, lower the central bank rate and lower reserve requirements. It can involve quantitative easing (QE), however, the risks are ramping up inflation. Contrarily, raising short-term interest rate can increases the cost of borrowing and effectively reduces its attractiveness to bring down the inflation which is known as tight monetary policy.

Quantitative Easing
It is the central bank pump money into the economy directly when the interest rate cannot go down anymore. The central bank whereby purchases assets (usually government bond) from the commercial bank and other financial intermediaries banks ,after that, they can absorb new money from selling assets to boost capacity to lend to individuals and businesses in order to achieve economic growth . It has been tried first by central bank in Japan when the period of deflation and asset bubble in 1990s . From Panel (a), the MPC conducts open-market operations in which it buys bonds. The MPC’s purchase of bonds shifts the demand curve for bonds to the right, raising bond prices to Pb2. As mentioned before, when the central bank purchase on bond will lead to an increase in money supply. The...
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