MONETARY POLICY

Monetary Policy and Growth

[Name of the Author]

[Name of the institute]

Monetary Policy and Growth

Introduction

Central Bank of a country is responsible for its monetary policy that controls and stabilizes various economic aspects of a country which entails supply of money, stable prices, credit availability, interest rates, investments and purchase of domestic/imported durable goods. A country's growth depends directly on interest rate and what type of market their businesses are operating in, which provides stable economic conditions. Growth and interest rate are inversely proportional to one another. The central bank lower's the interest rate by increasing circulation of cash or crediting bank reserves to offer growth by encouraging low sustainable prices, higher investment activities, low cost borrowing and exporting consumer goods abroad (White & Horace,1968, pp. 32). Appendix A defines the effectiveness of monetary policy (Along with fiscal policy) when money demand is left unaffected by the interest rate.

We will be discussing in detail the types monetary policies and tools that will promote growth in the long term and short term basis for a country and how it can influence the factors that raise output and employment as well as investment and consumer spending.

Discussion

Types of Monetary Policies

Taylor concluded that economic monetary policy can differ from one another; they can implement expansionary or contractionary actions depending on the economic conditions. These policies are used to control the base money circulation which is done by buying or selling of financial assets available in open-market operations (Taylor, 1999, pp. 333).

Expansionary Policy

This policy favours expansion by circulating money supply in open-market operations; it does so because it follows few characteristics of its own. The three most common characteristics of expansionary policy are:

Purchasing of Open market securities in the open market operations (Refer to Appendix B)

Reduce the central discount rate (Refer to Appendix C)

Reduce reserve requirements (Refer to Appendix D)

These characteristics allow the interest rate to fall. The Fed purchases securities which then increase the value of those securities affecting the interest rate to fall and bonds to rise. The case will always remain the same if the government decides to increase the money supply, the value for interest rate will always fall as discussed in detail in “Money and Banking” (White & Horace,1968, pp. 14-33). So expansionary policy will eventually increase the money supply in open-market which will have a positive impact in higher levels of capital investments and demand for foreign bonds will rise where as demand for domestic bonds will decrease. The difference in bonds value will cause the exchange rate of domestic currency to fall which will end up encouraging exports and lower imports to offer balance of trade.

Contractionary Policy

Contractionary monetary policy is opposite of what we have read in the expansionary policy. The Central open-market committee decreases the money supply by the combination on three things:

Sell securities in the open-market operations

Increase the central discount rate

Increase the reserve supplies

As we have understood the process of expansionary policy, the scenario of contractionary policy will be in contrast to that of expansionary, that is, the ...