Table of Contents

INTRODUCTION2

MONETARY POLICY2

THEORY ANALYSIS6

CONCLUSION16

WORK CITED19

APPENDIX24

Monetary Policy

Introduction

The objective for monetary policy is to try and establish economic growth with stable prices. The United States monetary policy affects not only all kinds of economic and financial decisions which are like applying a loan to buy a house, an automobile, to start business, or putting savings in a bank, buying bonds or stocks but also other countries' monetary policy. Monetary Policy is the regulation of the money supply and interest rates by a central bank in order to control inflation and stabilize currency. This policy influences the borrowing and spending of loan. The government attempts to influence the overall level of economic activity in line with its political objectives.

Monetary Policy Issues in the Year 2008-09

The recession that began with a cyclical peak in December 2007 originated in a combination of real shocks because of a fall in housing wealth and a fall in real income from an increase in energy prices. The most common explanation for the intensification of the recession that began in the late summer of 2008 is the propagation of these shocks through dysfunction in credit markets. The alternative explanation offered in this article emphasizes propagation through contractionary monetary policy.

The minutes of the Federal Open Market Committee (FOMC) held on October 29 have revealed that the Federal Reserve stands ready to ease monetary policy further even though FOMC members disagree as to the extent of the cuts. Some members have started to voice concern about a deflationary risk, which will become the dominant theme in coming months. The latest consumer price data has strengthened this concern, core inflation having pulled back by 0.1% month-on-month in October.

To counter this deflationary risk, the Fed will probably move rapidly to cut its federal funds rate target by 75bp to 0.25% by the year end (if not on December 16, then inter-meeting). We do not rule out the adoption of a zero interest rate policy (ZIRP) but the marginal impact would be slight. As regards the adoption of a quantitative monetary policy, the Fed is effectively already pursuing such a policy through the very strong expansion of its balance sheet. It will probably also use unconventional tools to avoid a possible deflationary spiral. On these lines, it could attempt to act on the yield curve (i.e. maintain low rates across the entire curve) by buying securities at various maturities, potentially risky securities. It is very likely that the US administration will use fiscal measures by putting into place a fiscal stimulus plan. Quite how much will be spent is unknown at this stage, but it will be a sizeable plan (at least USD 200bn, i.e. 1.5% of GDP). Given the governments' very active role in the conduct of economic policies, a deflationary scenario is not the most likely in our view despite most conditions being present. It is being recognized that the U.S. is giving due importance to its economy's key criterion, like the sustainable longer-term GDP outgrowth rate. The Fed and ...