Although they agree on goals, they disagree sharply on priorities, strategies, targets, and tactics. The money supply target means loss of control over the interest rate, while the interest rate target means loss of control over the money supply. These are open-market operations, the primary modus operandi of monetary policy. Friedman, therefore, argues that the monetary authority should concentrate on controlling the money supply rather than manipulating the interest rate. The Reserve Bank of Australia is responsible for formulating and implementing monetary policy. . Commercial banks by law hold a specific percentage of their deposits and required reserves with the Fed or a central bank.
The General Theory of Employment, Interest, and Money. If inflationary expectations are too low, it encourages low spending, low investment and deflationary pressures. Differential price changes are essential for allocating resources in the market economy. Let us assume in Fig. Policy can temporarily reduce the unemployment rate below its natural rate or, equivalently, boost employment above its long-run trend. Second, the credit structure has been greatly adjusted. The close relationship between the cash rate and other money market interest rates can be seen in Graph 2.
Should policymakers give priority to price stability or to full employment? The monetarists contend that as against fiscal policy, monetary policy possesses greater flexibility and it can be implemented rapidly. An appropriate monetary policy can, therefore, lessen fluctuations in general economic activities and can also reduce or prevent the degeneration of the economy. Thus unskilled workers are the worst sufferers because they are thrown out of jobs with automation. Economic Growth: In recent years, economic growth is the basic issue to be discussed among economists and statesmen throughout the world. Lower interest rates can make holding equities more attractive, which raises stock prices and adds to wealth. According to the monetarists, it is open market operations and changes in reserve requirements that are the main cause of movements in the money supply. In addition to banks, a number of government-sponsored enterprises--such as Fannie Mae, Freddie Mac, and the Federal Home Loan Banks--hold reserve balances at the Fed to facilitate large payment transfers to other institutions.
When the money supply increases it will be spent on bonds, thereby lowering interest rates and ultimately leading to an increase in investment. Treasury, against which they had incurred liabilities in currency Federal Reserve notes or in deposits convertible into currency on demand. Targets: Monetary Aggregates or Macroeconomic Performance? Exchange Stability: Exchange stability was the traditional objective of monetary authority. Since 1985, as the interest advantage of dollar assets was reduced or reversed, the dollar depreciated and the U. The Keynesian concept of full employment involves three conditions: i Reduction in the real wage rate; ii Increase in effective demand; and iii Inelastic supply of output at the level of full employment.
Full employment is consistent with 4 per cent unemployment in the economy. The second issue concerns the extent to which the money supply affects economic activity. In this case, a rise in interest rates causes a fall in consumer spending and investment leading to lower inflation. Monetary and fiscal policies are distinct only in financially developed countries, where the government does not have to cover budget deficits by printing money but can sell obligations to pay money in the future, like U. With this independence naturally comes a need for consultation and accountability.
But the ineffectiveness and inadequacy of such a policy in a depression was demonstrated both by the Keynesian analysis and the actual experience of depression of the 1930s, when the desire for liquidity made it impossible to increase funds for investment. They lend more and the economic activity is favourably affected. The background of the central government's steady monetary policy mainly includes the following aspects: First, after the real estate and development zone boom of the early 1990s, by 1997 and 1998, the risk of some small and medium-sized financial institutions has become quite prominent. Priorities also reflect divergent views of how economies work. The agreement between the Treasury and the Reserve Bank places strict controls on access to the overdraft facility, as well as imposing a market-related interest rate on the facility. A high interest rate policy is also anti-inflationary in nature, for it discourages borrowing and investment for speculative purposes, and in foreign currencies. About the Author Shane Hall is a writer and research analyst with more than 20 years of experience.
Instruments of Monetary Policy: The instruments of monetary policy are of two types: first, quantitative, general or indirect; and second, qualitative, selective or direct. The Bank makes a public announcement of any policy decision, giving detailed reasoning for it. Thus, it is clear from this fact that: the main objective of monetary policy is to maintain stability in the external equilibrium of the country. In fact, such a bank may even be able to borrow at a rate slightly below the rate of interest paid by the Fed by borrowing from one of the entities that is not eligible to receive interest on its reserve balances. The same view is held by the Keynesians. Full employment so defined is consistent with frictional and voluntary unemployment.
So interest rate as an indicator of monetary policy shows that when increase in the money supply leads to increase in interest rate, this will be like an expansionary easy money policy. On the other hand, if the money supply is below the existing demand for money at the given exchange rate, there will be a surplus in the balance of payments. By adding to the cash reserves of the commercial banks, then, the Fed enables those banks to increase their lending capacity. The opposite view suggests that targeting economic growth and lower unemployment is much more important — at least in a recession and liquidity trap. This is the output effect. Open-market operations thus amount to interventions in the federal funds market. Thus there is no conflict between unemployment and stable prices, as shown by the shaded area of the figure.
They also render monetary policy less effective by selling foreign assets and drawing money from their head offices when the Central bank of the country is following a tight monetary policy. This will raise the general interest rate structure in the market. Thus the nominal interest rate is not a good target of monetary policy. Investment, output, employment, income and demand rise, and fall in price is checked. There is also a stigma attached. Open Market Operations: Open market operations refer to sale and purchase of securities in the money market by the central bank.