Question

What is monetary policy, and who controls it?

What is the Quantity Theory of Money, and how does it inform monetary policy?

Answer 1

(1)

Monetary Policy : Monetary Policy is defined as the measures taken by the monetary authority to control supply of money is called monetary policy. Monetary policy aims at controlling money supply and thereby regulating the availability and cost of credit. The main objectives of monetary policy is to achieve price stability, reduction of unemployment and economic growth. Monetary policy is issued to achieve sustainable growth in the economy. There are many intruments which are used by the monetary authority. THe popular intruments are the Bank Rate and the Reserve Ratio. Bank rate is the rate at which FRS lends money to the commercial banks. It is the rate of interest paid by the commercial banks for taking short term loans from the FRS. Reserve Ratio is about bringing in suitable changes in CRR and SLR, so that the money supply in the economy could be achieved.

Monetary Policy is controlled by the Central Bank of each nation. Federal Reserve System is the Central Bank for United States and it will control the monetary policy to brining in sustainable economic growth.

(2)

Quantitative Theory Of Money : It is defined as a method to identify changes in price due to the change in money supply. It states that when the price increases money supply in the economy also increases and when price decreases money supply will also decrease. It tries to tell us that price and money supply are proportional to each other. Inflation or Deflation occurs either when the price in the economy increases or decreases respectively. So the inflation or delation could be easily identified.

Monetary Policy is issued only when there is a change in the money supply in the economy. Such changes in money supply ould be easily identified using the theory of Quantitative Theory Of Money. According to the theory when the price increases money supply will also increase. Hence the monetary policy could be issued inorder to sustain the money supply.