Tight money policy may cause people to spend faster; velocity rises. Therefore, a balanced growth is needed to breakdown the vicious circle which is only feasible with higher rate of capital formation. Currently the Fed communicates changes in monetary policy through changes in its target for the Federal funds rate. Price Stability: The objective of price stability has been highlighted during the twenties and thirties of the present century. The Fed may raise the reserve ratio, although this is rarely changed because of its powerful impact. Monetarists usually hold the adaptive expectations view of gradual change.
Thus, well-planned fiscal programme, public expenditure can help development of human capital which in turn possesses positive effects on income distribution. Changing the reserve ratio is very powerful since it affects banks lending ability immediately. Open-market operations are most important. Technology is now included because technology can replace employment. Sometimes, the policy of protection is a useful tool for the growth of some socially desired industries in an under-developed country. So monetary spending prevents this by stabling prices. Mainstream View of Self Correction 1.
A d ecrease in the discount rate signals that borrowing reserves will be easier and will tend to expand excess reserves. A monetary rule, then, would promote steady growth of real output along with price stability. Changing the Reserve Ratio 1. The Fed acts through open market operations, selling bonds to raise interest rates and buying bonds to lower interest rates D. According to European Central Bank, the basic objective of monetary policy is to improve price stability and achieve a high level of employment in the economy. The monetary policy also has an effect the way consumers spending and the interest rates that are given by banks. Banks would be highly affected by this because banks would be lending money at longer rates.
Instability can also arise from the supply side. What are the goals of monetary policy? The major strengths of monetary policy is that it stable prices. Capital Formation and Growth: Capital assumes a central place in any development activity in a country and fiscal policy can be adopted as a crucial tool for the promotion of the highest possible rate of capital formation. There is contraction of credit and prices are checked from rising further. It must be noted that if there is instability in the exchange rates, it would result in outflow or inflow of gold resulting in unfavorable balance of payments. Lower supervision costs prevail if workers have more incentive to work hard.
Banks would be highly affected by this because banks would be lending money at longer rates. Public expenditure, subsidies and incentives can favorably influence the allocation of resources in the desired channels. This tool consists of Federal Reserve purchases and sales of financial instruments, usually securities issued by the U. Their reserves are reduced and they lend less. The monetary policy was created to regulate the way money is handled. But ultimately it can only influence the price level in the economy.
To do this they would use an easy money policy. If people decide to save, it can affect both employment and the goods that can be reduced. This further gives rise to repeated wage-price spirals. Comment on the cause-effect chain through which monetary policy is made effective. The techniques; of monetary policy are the same as the techniques of credit control at the disposal of the central bank. Changes in interest rates affect consumer spending, savings and investment.
Generally, inequality in wealth persists in such countries as in the early stages of growth, it concentrates in few hands. Firms may not want to reduce wages if they fear problems with morale effort, and efficiency. Any monetary change is the root cause of all economic fluctuations. The monetarists contend that as against fiscal policy, monetary policy possesses greater flexibility and it can be implemented rapidly. Since the consumption function is more or less stable in the short period, the monetary policy should aim at raising investment expenditure. Comment on the cause-effect chain through which is made effective. Bank customer's deposits rise and therefore bank reserves rise by the same amount.
It is not expected to influence or discourage consumption and production in the economy. It can also affect the way people invest. Therefore, monetary policy promotes sustained and continuous economic growth by maintaining equilibrium between the total demand for money and total production capacity and further creating favourable conditions for saving and investment. Government leaders get re-elected for reducing taxes or increasing spending. I am familiar with What are the basic objectives of monetary policy? Net export effect occurs when foreign financial investors respond to a change in interest rates. Balance Sheet of the Fed A. Above all, direct curtailment of consumption and socially unproductive investment may be helpful in mobilization of resources and the further check of the inflationary trends in the economy.
Different objectives clash with each other and there is a problem of selecting a right objective for the monetary policy of a country. Monetary policy aims at influencing the economic activity in the economy mainly through two major variables, i. It is speedier and more flexible than fiscal policy since the Fed can buy and sell securities daily. The Fed does not set either the Federal funds rate or the prime rate; each is established by the interaction of lenders and borrowers, but rates generally follow the Fed funds rate. Classical economists believed in the existence of full employment which is the normal feature of an economy. In other words the cause-effect of Contractionary is the opposite of Expansionary. Monetarism argues that the price and wage flexibility provided by competitive markets cause fluctuations in product and resource prices, rather than output and employment.
The cause-effect chain through is that policy can have an effect on banks and money supply. This was the main objective under Gold Standard among different countries. Securities which are federal government bonds purchased by Fed, and 2. Capital formation and growth 8. Reserves of banks held as deposits at Federal Reserve Banks, 2. The federal funds rate is sensitive to changes in the demand for and supply of reserves in the banking system, and thus provides a good indication of the availability of credit in the economy. Businessmen are encouraged to borrow more.