This is an economic stabilization tool that operates through changes in the money supply. As the change occurs, the interest rate changes. A decrease in the money supply increases interest rate which has a negative influence on spending. Increases on the pending through lower interest rates. So in simple terms monetary policy refers to the government actions to alter the money supply and ultimate economic condition (spending). Federal Reserve: This is government argency with the responsibility for controlling the amount of paper currency in circulation.
The intention of the government is to create value to money as it is spent by consumers. Too much money supply would decline the purchasing power of money because people would have more than they needed and could try to get rid of the excess by spending. To avoid this, the Central Bank puts the following mechanism in controlling the money supply. (a)Open-market operations: Open markets are the buying and selling of government bonds on the money market by the Central Bank. In this act the Bank wants to reduce the size of the money supply by selling government bonds on the open market.
(Selling not restricted to certain groups), a willing buyer, a willing seller). By selling bonds, spendable money is removed from the circulation for it could have been used in purchasing the government bonds. On the other hand if the Central Bank wants to increase the amount of money in circulation, it will buy bonds back from the public by giving individuals and institutions money in return for bonds, this will increase purchasing power in the economy. (b)Defensive open market operation: This is a control measure where the Central Bank purchases and sales government securities to offset or neutralize the effects on bank reserves.
T his is done by bank borrowing at discount window (giving loans by Central Bank to other banks) or by draining of reserves by allowing people to take loans out of banks. (c)Buying of gold: This was used before the introduction of paper money. In this case the seller deposits the federals check in a bank account and the bank takes the check to the federal to increase its reserve account. (d)Lending additional funds to commercial banks: This is done by way of lending loans to Commercial Banks.
How do they influence money supply and affect macroeconomic factors: (a)One thing which is clear is that when Central Bank buys government securities, it tends to raise their prices- that are to lower their interest rates cetris-per purse and when the Central Bank sells government securities, it tends to reduce their prices that are to raise their interest rates. So what it means here is that people will borrow funds in order to buy more durable goods and firms would want to buy more investment goods more than they can pay for out of current income.
(b)Open defensive market operates most deals with the interest rates as a prerogative banks are not allowed to borrow to make a profit. All is required is to make some loans so as to meet its reserve requirements. This therefore permits the Central Bank the last resort loans to banks in financial trouble which might force them to close their doors. Effects of monetary policy on GDP, unemployement, inflation and interest rate on macroeconomic environment: Macroeconomics is the area of economic analysis concerned with the overall view of the country rather than an individual.
In fact as we have seen from above monetary policy is designed to reduce total spending by raising the cost of borrowing and limiting the availability of loans. In so doing its effects must be felt on the consumers and the general public. It is on this pernics that the Central Banks reacts in order to bring the economy joins into a safe and modesty spend. The general purpose here how does it affect the macroeconomic factors such as GDP, unemployment inflation and interest rate. We will discuss one after the other in the following order: INTEREST RATE:
According to Herdson &Poole(1991). Interest rate is defined as the price of credit in financial markets and is usually expressed as a percentage of the total amount borrowed that is to be paid each year(Over and above the repayment of the principal or amount borrowed ) The Central Bank sets the interest rate at the level expected to yield a target level of nominal GDP over the coming year. The Central Bank choice of the target level of nominal GDP depends on its view on how to achieve the best possible balance on employment and price stability goals.
When the Central bank fixes a high interest rate the corresponding effect on investment is also raised this is because the economic status is to create balance to avoid the real disturbance. Another effect of interest rate as a macroeconomic factor on monetary policy is to control money stock in circulation. Central Bank is on the watch out on the money stock, if the money demand schedule shifts outwards, Central Bank permits the money stock to increase to a desired level.
Similary if the financial disturbance has shifted money demand inwards, the Central Bank allows the money stock to fall, which would stimulate aggregate demand and push GDPabove the desired level. In economic terms, the tendency for interest rates to rise is either due to an upward shift in the investment –demand- function or of an upward shift in the money –demand function. That is to say if Central Bank holds interest rates steady then investment will rise and aggregate demand will end up higher than desired. GDP (Gross domestic products) stands for the value of goods and services produced in a country in a given year.
For an economy to be stable there must be a balance between the (GDP) which stands for domestic products and (GNP) which stands for international products. Other things being equal, high income countries consume more of all goods including imported ones and must export in order to obtain foreign currencies needed to buy imports. But generally in international trade it is acceptable that exports exceed imports what is termed as a favorable balance of trade. For a country to participate fully in the international market there must exist an export surplus a condition ment either adding of assets or reducing its borrowing.
Secondly, a country with an import surplus must be selling assets or increasing its borrowing. What determines here is the economic situation relative to that of other countries and not the condition prevailing in the markets. The critical requirement here is that one country must be willing to borrow and another is willing to lend. Before hand the country must consider the geographical destination of exports and origin of imports and the commodity breakdown. The macroeconomic policy on international trade is that the domestic products must be protected from foreign competition.
So, countries must limit imports through various measures: such as import Quata;-a limit on the quantity of a foreign produced good that can be imported; Import duty:-a tax levied on imports of goods. The whole concept is to protect domestic producers through artificial restriction on competition. The general effect is that these products are highly taxed which increases their prices in the market. C consumers are forced to cut down consumption or they must part away with an additional cost brought about the monetary policy of mercantilism. UNEMPLOYMENT.
Economics define unemployed person as one who is without a job but actively searching for work. Such kind of persons have their incomes are reduced making it difficult themselvesas well as their families. The worst part of it is deprivation of the sense satisfaction and social invest within a macroeconomic environment. As we have seen early the Central Bank has the prerogative to restrict the importation of foreign goods by issuing higher tariffs; which consequently the price of those goods behind the wishes of customers who does not want to know where the goods are produced.
The side effect here is that if the restriction persists most multinational companies will pull out of business and render its labor force unemployment. What we are saying here is that these companies though foreign owned, they offer employment to both from the country of origin and the country where it operates. Another aspect of unemployment is the availability of cheap labor in a macroeconomic environment. Foreign investors are sourcing the cheap labor than the expatriates who are expensive. So the low wage workers abroad create unfair advantage to the indigenous that may face an axe of losing jobs.
Inflation: Inflation is defined as an increase in the general level of prices. The general effect on the macroeconomic environment is that more money is required to buy a standard basket of goods that used to cost less. That is to say that a dollar won’t buy as much as it did before. The purchasing power is strained and cannot sustain consumption that calls for a reduction in the quantity demanded at a given time. If this situation persists the value of a currency dwindles to nothing and people are tempted to stop using the currency and it comes to have as much value as play money.
What that means is that the purchasing power of money is useless, commodities becomes very expensive and the general living standard of people becomes harder poverty level is increased. At this level then the Central Bank must come up with a monetary policy that must control the growing price index. Taxation must be checked as well as the cost of production. Another policy that most states use is the use of credit cards in major money outlets instead of using paper money, people are encouraged to trade using visa cards and control the money stock in circulation.
The government must accept some trade off and must bear certain risks. HOW IS MONEY CREATED To the economist money is paper money and coins which is commonly referred as currency. Unlike other goods which are used up when they are used up when they ar consumed, money does not disappear but it passes from one hand to the other, over and over again (circulates). In the same category we have bank deposits. Currency is not something one can legally create within the government there is a government arm that passes the bill on how to create money. This agency is responsible for controlling the amount of paper money in circulation.
Federal reserve must ensure that there is enough money in circulation so as to avoid it losing its purchasing power. Centrol bank raises the base by buying government securities, making loans to making loans to commercial banks and by buying valuable commodities such as gold, and gemstone . Secondly the government increases the base by writing checks to cover its expenditure, and decreases the bases when it collects taxes and sells securities to the general public To achieve the best balance in between economic growth, low inflation, and reasonable rate of unemployment could prefer to use interest rate policy and the money growth strategy.
References Calmfors, L. (2005) ‘Macroeconomic Policy, Wage Setting and Employment – What Difference Does the EMU Make? ’, Oxford Review of Economic Policy 14, pp. 125-151. Calmfors, L. (2006b) ‘Macroeconomic Policy Co-ordination in the EU: How Far Should It Go? ’, Swedish Economic Policy Review 8, pp. 3-14 Corricelli, F. , A. Cukierman and A. Dalmazzo (2006) ‘Monetary Institutions, Monopolistic Competition, Unionized Labor Markets and Economic Performance’, University of Sienna. Economic Survey (2007) Ministry