Question

Discuss the various monetary policy levers used by politicians and bureaucrats to guide the economy in the direction they deem most beneficial. Why do these policy levers produce unexpected results? How do these policy actions change your behavior regarding spending and saving?

Answer 1

Monetary policy levers used are:

Reserve requirements: Central banks determine what amount of reserves should be kept by the bank. If reserve requirement is high, banks will take out less loans and money supply will be low.

Interest rates: Low market interest rates induce borrowers to borrow more. It is done when the economy is in recession so that more people can continue spending.

Open Market Operations: This is conducted by Central banks to control the money supply. If it wants to reduce money supply, it sells governmnet securities, whereas to increase money supply, it buys securities.

Monetary policies show their results with a lag. For instance, in a period of recession, Central bank lowers interest rate. Even if investors take that money to invest in projects, that would take some time to show results. By that time, economy might have come out of recession. In that case, monetray policy can show unexpected results and do more harm than good.

Any policy that reduces the interest rate of the economy induces consumers to borrow more and save less, because savings rate are lower and it's cheaper to borrow money when interets rate is lower. Whereas when interest rates are high, it is expensive to borrow. Also, savings get a better return.