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Monetary Policy

The actions and inactions a central bank takes to control a country's money supply. Generally speaking, monetary policy refers to the setting of interest rates. If the central bank sets low interest rates, it increases the supply of money by easing the availability of credit. This promotes economic growth but in the long term can cause inflation. On the other hand, the central bank may adopt a restrictive monetary policy by setting high interest rates, which constricts credit and slows or eliminates growth while reducing inflation. Monetary policy may also refer to the printing of money, especially to repay government debts; this always causes inflation and is used as a last resort. See also: Hyperinflation.

Constrict monetary policy


The Federal Reserve actions that are designed to influence the availability and cost of money. Specific policy includes changing the discount rate, altering bank reserve requirements, and open-market operations. In general, a policy to restrict monetary growth results in tightened credit conditions and, at least temporarily, higher rates of interest. This situation can be expected to have a negative impact on the security markets in the short run, although the long-run effects may be positive because of reduced inflationary pressures

Inflation's effects on an economy are various and can be simultaneously positive and negative. Negative effects of inflation include a decrease in the real value of money and other monetary items over time, uncertainty over future inflation may discourage investment and savings, and high inflation may lead to shortages of goods if consumers begin hoarding out of concern that prices will increase in the future. Positive effects include ensuring central banks can adjust nominal interest rates (intended to mitigate recessions),[5]and encouraging investment in non-monetary capital projects.

The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money. For example, with inflation, lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers benefit. Individuals or institutions with cash assets will experience a decline in the purchasing power of their holdings. Increases in payments to workers and pensioners often lag behind inflation, especially for those with fixed payments.[11]

Negative
_ High or unpredictable inflation rates are regarded as harmful to an overall economy. _ make it difficult for companies to budget or plan long-term _ Uncertainty about the future purchasing power of money discourages investment and saving.[30] And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher income tax rates unless the tax brackets are indexed to inflation.

With high inflation, purchasing power is redistributed from those on fixed nominal incomes, such as some pensioners

whose pensions are not indexed to the price level _ affect the balance of trade Social unrest and revolts Inflation can lead to massive demonstrations and revolutions. For example, inflation and in particular food inflation is considered as one of the main reasons

Positive
it would allow labor markets to reach equilibrium faster.

Causes:
_ in the long run, the inflation rate is essentially dependent on the growth rate of money supply. _ in the short and medium term inflation may be affected by supply and demand pressures in the economy, and influenced by the relative elasticity of wages, prices and interest rates

MV = PT _ velocity of money is unaffected by monetary policy _

Controlling inflation

A variety of policies have been used to control inflation. _ High interest rates and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation _ Keynesians emphasize reducing aggregate demand during economic expansions and increasing demand during recessions to keep inflation stable _ A fixed exchange rate is usually used to stabilize the value of a currency _ a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability.

Open market:
_ Open market operations (also known as OMO) is the buying and selling of government bonds on the open market by a central bank. It is the primary means of implementing monetary policy by a central bank. The usual aim of open market operations is to control the short term interest rate and the supply of base money in an economy, and thus indirectly control the total money supply

Employment: _ In many European countries, unemployment-insurance programs are significantly more generous

A BOP crisis, also called a currency crisis, occurs when a nation is unable to pay for essential imports and/or service its debt repayments. Typically, this is accompanied by a rapid decline in the value of the affected nation's currency. Crises are generally preceded by large capital inflows, which are associated at first with rapid economic growth