Question

Monetarists, claim that central banks have to keep the money supply growing at a steady rate. They believe that fluctuations in the money supply are responsible for most large fluctuations in the economy. They argue that slow and steady growth in the money supply would yield stable output, employment, and prices. On the other hand, some economists believe that monetarist policy rule would work only under a certain circumstance otherwise it would be useless. According to these economists what is necessary for the monetary policy rule to be effective?

Answer 1

Monetary policy refers to a macro-economic policy that is advanced by the central and federal banks of various nations. This is the demand side economic policy which involves interest rates and management of money supply. The monetary policy is used by the governments of the respective countries to achieve macro-economic policies such as inflation, liquidity, growth, and rates of consumption (Chappelow, 2003). This macro-economic policy can be characterized as either being contractionary or expansionary. The Federal Reserve and Central Banks of respective countries have within its arsenal three powerful tools of economic control which include; open-air market operations, reserve requirement rates by banks, and discount rates. Early Keynesians had doubt on any long-lasting effects of monetary policy because regardless of discount rates, banks still have a choice to lend out the excess reserves they have at lower interest rates and the fact that the demand for goods and services by the consumer is not related to the cost of capital to obtain such goods (Schmidt, 2011). Additionally, the monetary policy is limited by the liquidity trap and time lags whose solutions will provide for in the explanation.

Explanation:

The difference between when a problem of macro-economic nature arises and the time that policymakers become aware of it is what is referred to as the recognition lag. This is considered to be perhaps the biggest challenge facing Central Banks and Federal Reserve Banks around the world. While it might be easy to show a recessionary gap and show how monetary policy will solve the gap in the graph, it takes several months to discover a real economic problem in reality. For instance, the 1990-1991 economic recession began in about July but was only discovered in late October. Only when policymakers realize there is a challenge with regards to the economy do they deal with it, even if it is months into the economic challenge. Implementation lag refers to the period between when the challenge is discovered and when a solution is enacted. While the implementation lag is short, the Federal Banks have to face the impact lag, this refers to the period between when the solution is enacted and when it starts to take effect. This challenge of monetary policy arises from the fact that solutions are tied to statistical reports collected over time. To solve this, dependence on statistical reports should stop and in its place, statistics from expected conditions in the future used.

The operation of Federal Banks and its resulting monetary tools can be affected by the prevailing political conditions of a country (Mchugh, 2011). In the United States, the relationship between Congress, the executive and the leadership of the Federal Reserve Bank of America ensures its independence. This independence is however varied across many countries in the world. While the federal banks are insulated, the people who work on these boards are affected by external pressures which could result in the implementation of monetary policies that are not directly demanded by the economy. To control this, countries should ensure that the terms of individuals who operate on these boards are elongated to ensure they are protected from political pressure.