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monetary policy

monetary policy

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Published by: rajan2778 on Mar 18, 2011
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Monetary policy  Monetary policy is the process by which the government. central bank or monetary authority of a country controls (i) the supply of money (ii) availability of money (iii) cost of money or rate of interest    in order to attain a set of objectives oriented towards the growth and stability of the economy .

GOALS OF MONETARY POLICY To assist the economy in achieving a fullemployment. non inflationary level of total output  Monetary policy is geared towards influencing interest rates  If government can affect interest rates. then the government can affect consumer and firm behavior .

and promotes consumer savings which decreases revenues by firms. contractionary policy  contractionary policy contractionary policy decreases the total money supply  involves raising interest rates in order to combat inflation  increasing interest rates slows the economy by making funds more expensive to firms.expansionary policy  expansionary policy increases the total supply of money in the economy  used to combat unemployment in a recession by lowering interest rates. .

..TOOLS OF MONETARY POLICY Open-Market Operations  Buying Securities  From commercial banks... Buying increases the money supply and lowers rates Public gives up securities Public deposits check in bank Banks have increased reserves .    Bank gives up securities FED pays bank Banks have increased reserves     From the public.

    FED gives up securities Bank pays for securities Banks have decreased reserves     To the public.Open-Market Operations Selling Securities  To commercial banks... FED gives up securities Public pays by check from bank Banks have decreased reserves Selling decreases the money supply and increases rates ...

The Reserve Ratio  Raising the Reserve Ratio – Banks must hold more reserves – Banks decrease lending – Money supply decreases  Lowering the Reserve Ratio – Banks may hold less reserves – Banks increase lending – Money supply increases .

The Discount Rate  Easy Money Policy – Buy Securities – Decrease Reserve Ratio – Lower Discount Rate  Tight Money Policy – Sell Securities – Increase Reserve Ratio – Raise Discount Rate .

An increase in money supply makes the economy feel wealthier by putting more money in the hands of consumers 2. An increase in money supply decreases interest rates  When interest rates are attractive to consumers and firms.Cause-Effect Chain Interest Rates and Money Supply  Interest Rates and Money Supplying money supply affect interest rates 1. they borrow & buy. hence increasing money supply increases economic activity .

MONETARY POLICY AND EQUILIBRIUM GDP Sm1 Sm2 Sm3 Investment Demand Real rate of interest. watch Price Level. GDP If the Money Supply Increases to Stimulate the Economy… Interest Rate Decreases Investment Increases AD & GDP Increases with slight inflation Increasing money supply continues the growth – but. i 10 8 6 0 10 8 6 0 Dm Quantity of money demanded and supplied Amount of investment. . i AS Price level P3 P2 P1 AD3(I=$25) AD2(I=$20) AD1(I=$15) Real domestic output.

Impacts of tight money policy2007  Excess aggregate demand pressures in the economy reduced  Hold in import demand  was successful in sustaining a downtrend in inflationary pressures  effective  liquidity management has allowed adequate growth in private sector credit .

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