Question

Central banks and monetary policy can be controversial topics. Present 2 arguments in favor of the view that monetary policy is effective and 2 arguments that monetary policy is ineffective or destructive. What is your view about the effectiveness of monetary policy? Explain your answer. be clear the length of the essay is short and half a page of A4 double space in the world document

Answer 1

Effective:

1. When the economy is in steady state, any new money pumped in the economy leads to real effect. As, investors now see lower rates and hence undertake some projects that they were not taking up earlier. Producers find more money in the market and they attribute it to economic boom, and in turn expand their production. Some consumers' nominal incomes increase and so they spend more on consumption. Therefore both demand and supply push aggregate output higher.

2. Weakening the Currency can boost exports, so by increasing the money supply or lowering interest rates tends to devalue the local currency. A weaker currency on world markets can serve to boost exports as these products are effectively less expensive for foreigners to purchase.

Ineffective:

1. Monetary Policy becomes ineffective in Long-Run. As we continue with it, we see real economy does not change no matter new paper money is added in circulation. So the push eventually weakens in the long run as prices adjust to neutralize expanded nominal money supply and only leads to changes in prices known as neutrality of money.

2. There are situations in which even in the short run monetary policy can be ineffective where it is not able to push real economy out of the established short run equilibrium. One of such condition is a fixed exchange-rate regime for national currency. In such cases the interest rates are taken from outside. When currencies are fixed against one another their interest rates move together. In such a scenario, domestic Central Bank find it hard to affect domestic interest rates and hence domestic equilibrium money supply. Whatever additional money printed will be not needed in the economy and will eventually be sold by the market participants back to CB in exchange for part of foreign currency reserves.

3. Another case where monetary policy is ineffective is when there are very low interest rates, a situation known as liquidity trap. Expansionary monetary policy mainly works through lower nominal interest rates. When it cannot push rates further down, monetary policy is ineffective in one direction. For such a scenario, policy makers should try to devise some other means of helping the economy through, giving birth to different kind of quantitative easing.

My view:

Monetary policy has less impact on the real economy. Expansionary monetary policy have limited effects on growth, by increasing asset prices and lowering the costs of borrowing, making companies more profitable. In addition, it has the psychological benefits of taking care of worse-case economic scenarios.

Unconventional monetary policy is the best way to adopt. This category includes quantitative easing, the purchase of varying financial assets from commercial banks. In the US, the Fed loaded its balance sheet with trillions of dollars in Treasury notes and mortgage-backed securities between 2008 and 2013. The Bank of England, the European Central Bank and the Bank of Japan have pursued similar policies. The effect of quantitative easing is to raise the price of securities, therefore lowering their yields, as well as to increase total money supply.