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| Monetary Policy |
The activities made by a country's central bank to achieve its macroeconomic policy objectives are referred to as monetary policy. Some central banks are entrusted with keeping inflation at a specific level. The Federal Reserve Bank (the Fed) was created in the United States with the goal of achieving maximum employment and price stability.
The Fed's "dual mandate" is a term used to describe this. In most countries, the monetary authority is kept apart from any outside political influence that could jeopardise its mandate or obscure its objectivity. As a result, many central banks, such as the Federal Reserve, are run as separate entities.
When a country's economy expands at such a rapid rate that inflation becomes a concern, the central bank will use restrictive monetary policy to tighten the money supply, thus limiting the amount of money in circulation and slowing the rate at which new money enters the system. Raising the current risk-free interest rate will raise the cost of money and increase borrowing costs, reducing demand for cash and loans.
The Fed can also raise the reserve requirements for commercial and retail banks, limiting their ability to make new loans. Selling government bonds to the general public on the open market reduces the amount of money in circulation. The Monetarist school of economics believes in the benefits of monetary policy.
When a country's economy enters a slump, these same policy tools can be used to reverse the trend, resulting in a loose or expansionary monetary policy. Interest rates are dropped, reserve restrictions are loosened, and bonds are bought in exchange for newly produced money in this situation. If traditional methods fail, central banks can use unconventional monetary policies like quantitative easing to help .
Pros of Monetary Policy
Interest rate targeting keeps inflation under control.
In a rising economy, a modest bit of inflation is beneficial because it drives future investment and allows people to expect increased pay. Inflation is defined as an increase in the overall price level of all goods and services in a given economy. Investment becomes more expensive as the target interest rate rises, slowing economic development slightly.
Is It Possible To Implement Quite easily
Central banks can employ monetary policy tools fast. Often, simply announcing their goals to the market is enough to get results.
Central banks are politically neutral and independent.
Even if monetary policy actions are controversial, they can be implemented prior to or during elections without fear of political consequences.
Exports can be boosted by weakening the currency.
Devaluation of the local currency occurs when the money supply is increased or interest rates are lowered. A lower currency on global markets can help promote exports by making these products more affordable to international buyers. Companies who are mostly importers would experience the opposite effect, harming their bottom line.
Cons of Monetary Policy
There is a time lag between effects.
Even if enacted swiftly, monetary policy's macro consequences usually take some time to manifest. It may take months or even years for the consequences on an economy to manifest. Some economists believe that money is "only a curtain," and that while it can stimulate an economy in the short term, it has no long-term benefits other than to raise the general level of prices without increasing real economic activity.
Technical Constraints
Interest rates can only be cut to 0% nominally, limiting the bank's use of this policy instrument when rates are already low. Maintaining extremely low interest rates for an extended length of time can result in a liquidity trap. During economic booms, monetary policy measures are more effective than during recessions. Negative interest rate policies (NIRP) have lately been tried by certain European central banks, although the results will take time to emerge.
Monetary Tools are broad in scope and have an impact on the entire country.
Interest rate levels, for example, have an economy-wide influence and do not account for the reality that some sections of the country may not require stimulus while states with high unemployment may want it more. It's also broad in that monetary instruments can't be targeted to tackle a specific problem or enhance a certain industry or region.
Hyperinflation
Over-borrowing at artificially low rates can occur when interest rates are set too low. This can lead to a speculative bubble, in which prices rise at an abnormally fast pace and to ridiculously high heights. Because of the premise of supply and demand, adding more money to the economy can lead to out-of-control inflation. If more money is available in circulation, the value of each unit of money will decrease given an unchanged level of demand, making things priced in that money nominally more expensive.
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