Question

Question one
For this question, refer to the Bank of Ghana’s Monetary Policy Committee Press Release of March 18, 2020.
a) In ordinary language, explain the meaning of monetary policy. What is the difference between monetary policy and fiscal policy?
b) Explain the difference between monetary loosening and monetary tightening.
c) According to the statement, the MPC reduced the monetary policy rate by 150 basis points. Does this constitute a monetary loosening or monetary tightening? Explain
d) When deciding whether to tighten or loosen monetary policy, central banks weigh the relative risks to price stability and growth. Mention two indicators that the MPC use to gauge the risk to inflation and two indicators the MPC use to gauge the risk to growth.
e) Based on the information in the Press Release, in the thinking of the MPC did the risk to growth outweighed the risk to inflation or vice versa? Refer to specific points from the press release to back up your argument.
f) Using the money market diagram, explain the effect of this policy measure on the real interest rate and real money holdings.
  
g) In ordinary language, explain how the reduction in the Monetary Policy Rate will help the relative risk identified in part (e) above.
h) In addition to the reduction in MPR, the MPC also reduced the Primary reserve requirement from 10% to 8%. Explain how this

Answer 1

a) A monetary policy refers to the policy adopted by the monetary authority of a nation, generally the central bank of a nation that aims at controlling the short-term interest rate or the money supply in an economy. A monetary policy is often implied to target the inflation or contraction in an economy in order to maintain the price stability and ensure the general trust in a currency.

A fiscal policy is a policy measure adopted by the governing body of a nation wherein it adjusts the spending level and tax rates to regulate the inflationary or contractionary tendencies in an economy so as to maintain a balance in the pricing levels in an economy.

Thus, we can see that a monetary policy is often concerned with the regulation in the interest rates and the money supply in an economy whereas a fiscal policy is aimed at regulating the taxation levels and the government spending in an economy to maintain a balance in the pricing levels in an economy

b) ‘Monetary loosening’ refers to an expansionary fiscal policy and ‘Monetary tightening’ refers to a contractionary fiscal policy. The following are the major differences between the two

· A loosening monetary policy is adopted at times of lower inflation levels and a tighter monetary policy is adopted at times of higher inflation

· An expansionary policy results in a lower interest level and thus decreases the attraction towards saving in an economy and a tightening policy would lead to higher interest rates and hence boosts savings of an economy.

· With reduced savings, an expansionary policy would lead to more money supply in an economy and thus helps in regenerating the lost demand in an economy

· With increased saving levels, a contractionary policy would lead to lower money supply in an economy and thus leads to lesser demand in an economy

· Thus, a contractionary policy would lead to lesser investment patterns and an expansionary policy would lead to improved investment patterns in an economy

· Finally, an expansionary policy would lead to reducing the deflationary effects and a contractionary policy would lead to reducing the inflationary effects in an economy.

c) A reduction in the monetary policy rate refers to a reduction in the interest rate in an economy which corresponds to an expansionary or loosening monetary policy as discusses earlier. In the given case, the reduction of monetary policy rate by 150 basis points would mean that the interest rates in an economy has been reduced by 1.5%. With this measure, the savings in an economy would be less attractive and the spending in an economy would be improved. With improved spending, the money supply would be improved which would lead to an improved investment pattern in an economy. Thus, it is clear that by reducing the interest rates, an expansion of the economy would happen.

d) The two major indicators that helps in identifying the risk to inflation in an economy are the changes thar are happening to the Consumer Price Index [CPI] and the Personal Consumption Expenditure [PCE]. A CPI would help in measuring the changes in the price of the basket of goods and services that are being consumed by the households. The Personal Consumption Expenditure would help in indicating the changes of the individual expenditure patterns in an economy and hence would be deterministic of the inflation levels in an economy.

The two major indicators of the risk to growth in an economy are the current GDP levels and the unemployment rate in the economy. A better GDP level means better output in an economy and hence would indicate a better economic growth and similarly a better employment rate or a lower unemployment rate would also mean a better participation of the work force and hence would indicate a better economic growth.