Question

Discussion 9.2: Monetary Policy

Participate in a discussion with your classmates regarding how monetary policies affect our lives. Review the “EYE on Your Life” caption titled, Your Views on Monetary Policy and How Monetary Policy Affects You, on page 449 in the textbook. Utilizing the knowledge that you have accumulated during our course, and by reading or watching the current news, determine the monetary policy issues that face our economy today. Specifically, discuss whether the greater monetary policy risk is inflation or recession, and share what actions you expect the Fed to take, as explained in the textbook, regarding their strategies to alleviate inflation or recession risks.

Answer 1

First of all we should know that "What is Monetary Policy?"

Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.In simple words it is used as a tool by the central bank to control inflation or money supply etc.Monetary policy is how central banks manage liquidity to create economic growth.

There are two types of monetary policies:-

1.Contractionary monetary policy:- This monetary policy slows the rate of growth in the money supply or outright decreases the money supply in order to control inflation.Central Bank raise the interest rates so people or banks will borrow less money because of high interest rates that will slows the rate of money supply and thus inflation can be controlled.contractionary monetary policy can also slow economic growth, increase unemployment and depress borrowing and spending by consumers and businesses.The central bank can sell securities through open market operations to decrease liquidity.

2.Expansionary monetary policy :-Expansionary monetary policy increases the money supply in order to lower unemployment, boost private-sector borrowing and consumer spending, and stimulate economic growth.In this type of policy central bank decreases interest rates so it will lead to increase in money supply because of lower interest rates and thus recession can be controlled.Central bank can buy securities from member banks to increase liquidity.

Now coming to your question that ''how monetary policy affect our lives?''

So if there will be Expansionary monetary policy, then borrowing will be cheap, firms will take on more debt to invest in hiring and expansion; consumers will make larger, long-term purchases with cheap credit; and savers will have more incentive to invest their money in stocks or other assets and you will have more chances of employment But there are some disadvantages also if this policy is not implemented in a controlled manner it can lead to inflation in the economy.

If there will be Contractionary monetary policy,then borrowing will become costly,we will borrow less money because of higher interest rates and there will be less chances of employment but it can control inflation which is good for us.

so this is how a monetary policy affects our lives.

Now coming to your next question that "which is the greater monetary policy risk : inflation or recession?''

"Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time while Recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters."

We know that inflation and recession both can be bad for the economy sometimes but it depends on a person that which is greater risk for him or her. For example, retirees are generally more exposed to the risks of inflation than deflation. Thus, they should avoid long-term nominal bonds. On the other hand, deflation is the greater risk for younger investors with stable jobs, wages likely to keep up with inflation and high equity allocations.As i already dicussed that Deflation could lead to increased risk of job loss and negative impacts on their equity holdings. Longer-term bonds hedge those risks better than do short-term bonds.

Now coming to your last question that how to alleviate inflation or recession risks.So as we already discussed that Inflation can be controlled through Contractionary monetary policy and Recession can be controlled through Expansionary fiscal policy. So we can colclude that central bank should implement monetary policy according to the situation and should maintain a balance in the economy.