Question

Monetary authorities should tend to carry out active monetary policy in any policy making. This is because active monetary policy will quickly respond to economic conditions, both global and domestic, to control the stability of the domestic economy. In addition, taking a long time of monetary policy will have an impact on the economic crisis because there is no policy that can immediately handle changes in economic conditions. Discuss this!

Answer 1

Monetary policy is the macroeconomic policy laid down by the central bank of a countryon which the government exercise a control over. It is the policy relating to the regulation of supply of money, rate of interest and availability of money, with a view to combat situation of inflationary or deflationary gap in the economy. Also the government control the liquidity of money through monetary policy. The main instruments in a monetary policy includes :-

1] Open Market Operations

2] Bank Rate

3] Variable Reserve Requirement ( CRR and SLR)

4] Liquidity Adjustment Facility

5] Moral Suasion

>An economy with an active and efficient monetary policy will be able to quickly respond to the economic conditions good or bad. we can take some extremen economic conditions and see how a monetary policy will help a nation to overcome that.Like for example, a recession, consumers stop spending as much as they used to; business production declines, leading firms to lay off workers and stop investing in new capacity; and foreign appetite for the country’s exports may also fall. In short, there is a decline in overall, or aggregate, demand to which government can respond with a policy that leans against the direction in which the economy is headed.

>Such a countercyclical policy would lead to the desired expansion of output (and employment), but, because it entails an increase in the money supply, would also result in an increase in prices. As an economy gets closer to producing at full capacity, increasing demand will put pressure on input costs, including wages. Workers then use their increased income to buy more goods and services, further bidding up prices and wages and pushing generalized inflation upward—an outcome policymakers usually want to avoid.

> It also plays an important role in combatting economic slowdowns. Such adjustments can be made quickly, and monetary authorities devote considerable resources and time to monitoring and analyzing the economy. Monetary policy can offset a downturn because lower interest rates reduce consumers’ cost of borrowing to buy big-ticket items such as cars or houses. For firms, monetary policy can also reduce the cost of investment. For that reason, lower interest rates can increase spending by both households and firms, boosting the economy.

>The Central bank can adjust monetary policy more quickly than the government can adjust the fiscal policy. Because most contractions in economic activity last for only a few quarters, a prompt policy response is crucial. Yet fiscal policy in practice responds slowly to changes in economic conditions: it takes time first to enact a stimulus bill and then to implement it, and time for the spending increases or tax reductions to reach consumers’ pockets. As a result, the effect of fiscal stimulus on household and business spending may come too late.

> Though the potential of monetary policy to combat extreme events is limited, however, because its primary tool is the short-run interest rate, and that rate can’t fall below zero. That means that in a particularly severe downturn such as the recent Great Recession, the Central Bank of a nation will reduce the short-run interest rate to zero, after which the it can employ only less effective and well-understood policies such as asset purchases( which will increase money supply). Under those conditions, fiscal policy may complement monetary policy in boosting the economy.

> To conclude the monetary policy can very well handle the future economic conditions to a great extent by using the instruments mentioned above, To ensure that more independency should be given to the economic policy makers by the people in power so that a quick action could be taken, as the economists are regularly monitoring vand analysing the situations of an economy. Also the monetary policy might not be much effective to control major unforeseen and extreme events such as the great economic depression or a world war .