Question

Central Bank and monetary policy can be controversial topics. Present 2 argument in favor of the view that montary policy is effective?

Answer 1

Central Bank of a country is responsible for controlling inflation in the country, the central bank controls inflation through monitory policies. It is a process through which the monitory authorities (Federal Reserve + FOMC etc.) determines the size and growth rate of money supply in the economy.

1. Now the monitory policies are made effective by following the expansionary and the contrationary monitory policies, this are actually the quantitative tools. Through expansionary monitory policies, central bank increases the supply of money in the economy, by deacresing the statutory liquidity ratios, interest rates, bank rates etc. It is also known as cheap money policy, it might result in high inflation, whereas through contrationary monitory policy, the central bank decreases the supply of money by increasing the interest rates, SLR, bank rates etc, It is called tight monitory policy or dear money policy.

2. Also the central bank through its qualitative tools make the monitory policies effective. It consist of tools like consumer credit, in which the central bank controls inflation by limiting the availability of installments through banks on purchase of certain goods, Through direct action it makes the commercial scheduled banks to cooperate with the central bank to achieve desirable outcomes, Through credit rationing it controls the flow of credit to certain priority sectors.