MANAGERIAL ECONOMICS

Assignment - I

Monetary Policy as a Tool For Achieving Economic Objectives

Monetary Policy as a Tool For Achieving Economic Objectives

MEANINGMonetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.  The official goals usually include relatively stable prices and low unemployment. Monetary economics provides insight into how to craft optimal monetary policy.

Monetary policy is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in order to avoid the resulting distortions and deterioration of asset values.

Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing

GOALS OF MONETARY POLICY

InflationInflation results in a drop in the value of money. Inflation can have a negative impact on savings accounts and investments because of reduced values in currency. As money loses value, so do wages, pensions and investments. Prices go up, making daily living harder. Fighting inflation has been the main traditional goal of monetary policy.

StabilityOne of the most important goals of monetary policy is stabilizing currency values. The benefit is that investors and businesses can rely on the value of the currency and, therefore, can make intelligent decisions about long-term investments.

Interest RatesKeeping interest rates stable is another important goal. A balance must be struck between the desires of investors to see a large return on investment with higher interest rates with borrowers who want low interest rates on loans. Striking a balance between these two

interests is important for monetary policy because both promote economic growth, savings and investment.

Balance of PaymentsIf a specific currency gains in value relative to its neighbors, goods from that country, when sold abroad, will be more expensive. As the value of the currency falls, the competitiveness of goods from that economy becomes more competitive abroad. Again, a balance must be maintained between these two poles: a strong currency that speaks to low inflation at home, and a weak currency that might boost international sales. As a specific currency falls in value, the debts incurred in that currency also fall in value. Therefore, a currency that is too strong might make international debts that much higher.

HOW MONETARY POLICY AFFECTS ECONOMIC OBJECTIVES.

Control InflationOne of the primary impacts of monetary policy is on inflation. The goal of monetary policy is to control inflation, or the value of currency, through changes in monetary policy tools. When inflation rises, the central bank typically raises interest rates. High inflation makes the costs of goods higher. Central banks want to keep inflation low to keep the prices of goods stable relative to the value of the currency.

Interest RatesMonetary policy directly impacts interest rates. The central bank raises or lowers the prime rate, or interest rate the central bank loans money to other banks, as a tool to impact the economy. These actions have a trickledown effect on the interest rates charged on loans, credit cards and any other financial vehicle that is tied to the prime rate.

Business CyclesBusiness is cyclic in nature and goes through periods of expansion and contraction. Monetary policy attempts to minimize the speed and severity of these expansions and contractions to maintain steady growth or decrease a negative contraction. The goal is to keep an economy on a slow, but steady growth pattern to prevent recessions during periods of contraction.

Spending

Monetary policy impacts the amount of money spent in an economy. When a central bank decreases interest rates, more money is typically spent in an economy. This increase in spending can equate to better overall health for an economy. Likewise, when interest rates are increased, spending declines, this could curtail inflation.

EmploymentEmployment levels relate to the health of an economy. When inflation is low and an economy is stable or in an expansionary phase, employment levels are higher than when inflation is high and an economy is in a contraction phase. Changes in monetary policy that maintain economic stability and minimize inflation, tend to keep unemployment low