What is Monetary Policy?

What Is Monetary Policy?

Monetary Policy is implemented by a central bank or currency board and involves controlling the following areas;

  • Money supply in order to control inflation.
  • Maintain or stimulate economic growth.
  • Lower unemployment.
  • Maintain a stable exchange rate.

Depending on the economic conditions a central bank may set a monetary policy that affects one area positively but has a negative effect on another area.

For example;

To control inflation the central bank will decrease money supply which can lead to a slowdown in economic growth and unemployment.

Increasing money supply would lower unemployment and increase economic growth but will eventually lead to inflation.

Types Of Monetary Policy?

As mentioned previously a key role of central banks is to implement monetary policy.

Monetary policy can be split into two types, these are expansionary and contractionary.

Expansionary Monetary Policy

Expansionary monetary policy involves a central bank using its tools to stimulate economic growth,  usually implemented after a period of recession.

A central bank can do this by implementing “easy monetary policy,”  this involves increasing the money supply in order to lower unemployment, boost private-sector borrowing and consumer spending.

As interest rates have been lower it is easier for banks and lenders to loan money leading to increased economic growth.

A central bank could also implement Quantitative easing (QE), which involves a large-scale asset purchases.

QE involves a central bank buying predetermined amounts of government bonds or other financial assets in order to stimulate the economy and increase liquidity.

Quantitative easing is seen as an unconventional form of monetary policy, it is usually used when standard monetary policy has become ineffective.

Contractionary Monetary Policy

Contractionary monetary policy is when a central bank seeks to control inflation by slowing the growth rate/decreasing the money supply.

High inflation is seen as a sign of an overheated economy and so the bank will raise interest rates to try to combat this.

Slow economic growth, increase unemployment and decrease in borrowing and spending are results from contractionary policy, (also known as restrictive monetary policy).

Although increasing interest rates can combat inflation it also often triggers a recession in an economy.

What Are Central Banks Targets?

Central banks have a wide array of tools to implement monetary policy and not all use the same tools at the same time or have the same targets.

They do however have similar roles in trying to keep balance in the economy, prices stable and maintain economic growth.

Since the 1980’s inflation has emerged as the leading target in monetary policy with many major central banks now introducing inflation targets.

Below we have listed some of the main central banks with the monetary policy and targets.

The Federal Reserve (Fed)

Works to promote a strong U.S. economy and have three specific goals. employment, inflation and interest rates.

  • Maximum sustainable employment with unemployment between 4.2 to 4.8 percent.
  • Stable prices with inflation at the rate of 2 percent.
  • Moderate long-term interest rates aiming for 3 percent by 2020.

The European Central Bank (ECB)

Works to is to maintain price stability in the EU economy:

  • Stable prices with aims to keep inflation below, but close to, 2%

The Bank of England (BOE)

Has a main goal to reach the target rate of inflation but also has secondary objectives such as growth and employment:

  • Stable prices with inflation at the rate of 2 percent.

The Reserve Bank of Australia (RBA)

Has a goal to maintain price stability, full employment, and the economic prosperity.

  • Stable prices with inflation at the rate of 2–3 per cent.

The Bank of Canada (BOC)

Has a goal is to preserve the value of money by keeping inflation low, stable and predictable.

  • Inflation control at the rate of  two per cent, the midpoint of a 1 to 3 per cent target range.

The Bank of Japan (BOJ)

Has a goal aimed at achieving price stability to achieve “sound development of the national economy”.

  • Price stability target at 2 percent inflation.

The Swiss National Bank (SNB)

Works towards achieving price stability and does so through Three-Month Target Libor Rate.

  • National consumer price index (CPI) of less than 2% per year.

As you can see a lot of the central banks listed above have made inflation one of their main targets.

Most of the central banks have an inflation target of around 2 percent and will use the certain tools available to maintain their targets.

 

 

 

 

 

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