MONETARY POLICY AND INTEREST RATE

Monetary Policy and Interest Rate



Monetary Policy and Interest Rate

Monetary Policy is the process undertaken by monetary authority of concerned country to control the supply of money, usually targeting a rate of interest. Generally Monetary Policy exercised to achieve a set of goals towards the growth as well as stability of economy. Normally these objective or goals contains reduction of unemployment and stability of prices. Monetary theory provides way to make best monetary policy.

Monetary policy can be either an expansionary policy, or a contractionary policy. Where an economy increase the total supply of money rapidly is said to be Expansionary Policy and when an economy decrease the total supply of money or increase it unhurriedly it is called contractionary Policy. Expansionary Policy generally used to overcome unemployment in the recession by decreasing the interest rate. Whereas, the Contractionary Policy is used to meet the inflation by increasing the rate of interest. (Friedman, 1968)

Monetary Policy rests on the association of rates of interest in an economy. The money can be borrowed and can supply on this price. Monetary policy is a tool to have power over inflation, exchange rate with foreign currencies, economy growth and unemployment. The most important thing which policymakers should follow is to make a reliable policy and denounce interest rate targets because they are not much important in respect of monetary policy. If an employee thinks the price to be higher in future then he/she would create a contract with higher wages to meet this high price. So the belief of lesser wages indicates wages-setting behavior among personnel and owners and while wages and lesser there cannot be demand-pull inflation as employees are getting a minor wage and there will no cost-push inflation as employer are playing not much money in wages. (Mishkin, 2001)

Normally, monetary policy is largely a fiat matter meaning a central banker, if determined enough, can expand or contract the supply of money as they please. If money supply is expanding, it is reasonable to expect prices to increase, and a bubble to possibly form in a given sector. If money supply is contracting, we can expect prices to likely decrease, and a bust to occur in a given sector. Which sector bubbles and busts will appear in depend on other economic factors. Because monetary policy is dependent largely upon the will of central bankers, understanding the psychology of central bankers is extremely critical. In terms of what news to pay attention to, news that reveals whether the central bankers want inflation or deflation, and how determined they are to reach their objectives, is particularly important. It is also worth observing whether free market forces are in line with or opposed to central banker objectives. If there is opposition, we should then ask ourselves whether central bankers are sufficiently determined to overpower free market forces and create the monetary policy they desire. For instance, over the past several decades, the Bank of Japan has seeking to create a weaker currency, but ...