Monetory policy

Topics: Monetary policy, Inflation, Central bank Pages: 10 (2785 words) Published: October 5, 2013
Monetary Policy
Monetary policy is the process in which a government, central bank, or monetary authority of a country uses to control (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy. Monetary theory provides insight into how to craft optimal monetary policy. Objectives of Monetary Policy:

Monetary policy is one of the tools that a national Government uses to influence its economy. Using its monetary authority to control the supply and availablity of money, a government attempts to influence the overall level of economic activity in line with its political objectives. Usually this goal is "macroeconomic stability" - low unemployment, low inflation, economic growth, and a balance of external payments. Monetary policy is usually administered by a Government appointed "Central Bank", the Bank of Canada and the Federal Reserve Bank in the United States. Monetary policy is contrasted with fiscal policy, which refers to government borrowing, spending and taxation.

Types of Monetary Policy
Monetary policy is referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates to combat inflation. Furthermore, monetary policies are described as follows: accommodative, if the interest rate set by the central monetary authority is intended to create economic growth; neutral, if it is intended neither to create growth nor combat inflation; or tight if intended to reduce inflation.

Monetary Policy:
Target Market Variable:
Long Term Objective:
Inflation Targeting
Interest rate on overnight debt
A given rate of change in the CPI
Price Level Targeting
Interest rate on overnight debt
A specific CPI number
Monetary Aggregates
The growth in money supply
A given rate of change in the CPI
Fixed Exchange Rate
The spot price of the currency
The spot price of the currency
Gold Standard
The spot price of gold
Low inflation as measured by the gold price
Mixed Policy
Usually interest rates
Usually unemployment + CPI change

The different types of policy are also called monetary regimes, in parallel to exchange rate regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results in a relatively fixed regime towards the currency of other countries on the gold standard and a floating regime towards those that are not. Targeting inflation, the price level or other monetary aggregates implies floating exchange rate unless the management of the relevant foreign currencies is tracking the exact same variables (such as a harmonized consumer price index).

Problems of Implementing Monetary Policy in Developing countries Developing countries may have problems establishing an effective operating monetary policy. The primary difficulty is that few developing countries have deep markets in government debt. The matter is further complicated by the difficulties in forecasting money demand and fiscal pressure to levy the inflation tax by expanding the monetary base rapidly. In general, the central banks in many developing countries have poor records in managing monetary policy. This is often because the monetary authority in a developing country is not independent of government, so good monetary policy takes a backseat to the political desires of the government or are used to pursue other non-monetary goals. For this and other reasons, developing countries that want to establish credible monetary policy may institute a currency board or adopt dollarization. Such forms of monetary institutions thus essentially tie the hands of the government from...
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