Question

1. Compare and contrast explaining in detail the making of monetary policy between the Federal Reserve System in the USA and the European Central Bank.

Answer 1

    In U.S.A , Federal Reserve System has the power to enact monetary policy. The main aim of monetary policy are promoting maximum employment, stability of prices through a moderate level of inflation and long term interest rates. Federal Reserve have to use three tools to implement monetary policy -

1. Open market operations, 2. Discount rate and 3.Reserve requirements. The Board of Governors of the Federal Reserve System is responsible for setting up of discount rate and reserve requirements and the Federal Open Market Committee is responsible for open market operations. Bu using these three tools, Fed influences the demand for and supply of money in the U.S. economy that the commercial banks should keep at Federal Reserve Banks and this way Fed can alters the federal fund rate. Changes in the federal fund rate affect the variables like market short term interest rates, foreign exchange rates, long term interest rates, amount of money and credit, unemployment ,output and prices of good and services. During a recession ,Fed enacts expansionary monetary policy by reducing discount rate ,reserve requirements and purchasing government bonds from open market . It will reduce both short term and long term interest rates, increases amount of money and credit and thereby it rise employment, output and price of good and services .During an inflation , ,Fed enacts contractionary monetary policy by increasing discount rate ,reserve requirements and selling government bonds from open market . It will rise both short term and long term interest rates, reduces amount of money and credit and thereby it reduce employment, output and price of good and services Monetary policy by European Central Bank In European Union , ECB enacts monetary policy by using a range of instruments such as open market operations, standing facilities and holding of minimum reserves .The main objective of ECB is to maintain price stability and promote economic growth .In order to achieve this objective, Governing Council of ECB has using two pillar monetary policy strategy and implements using both standard and non standard monetary policy measures.

First pillar of monetary policy strategy It focuses on real activity and financial conditions in the economy . ECB regularly reviews the developments in overall changes in output, demand and labor market conditions with a wide range of price and cost indicators,fiscal policy and Balance of Payments of EU

Second pillar of monetary policy strategy It focus on the link between price money and prices. Monetary analysis included detailed analysis of monetary and credit developments to assess the future implication of inflation and economic growth. During inflation , ECB apply contractionary monetary policy and during recession it implements expansionary monetary policy.