Question

Monetary policy
a) Why do we need monetary policy and what is its purpose?
b) What are the main transmission channels by which monetary policy achieves its objectives?

Answer 1

a) Monetary policy is a policy that is adopted by country's monetary authority which controls the interest rate that is payable on short-term borrowing. Monetary policy are needed to increase liquidity so as to create economic growth. Monetary policy is used to reduce liquidity so as to prevent inflation. It is used to tackle unemployment.

Purpose of Monetary policy:

• One of the primary purpose of monetary policy is to control and maintain low inflation rate
• To achieve a long-term GDP growth trend.
• To achieve sustained growth rate.
• To generate employment.
• To improve the quality of life of the population.

b) The main transmission channels by which monetary policy achieves its objectives:

• Traditional Interest rate channels: It leads to decrease in real estates. This leads to reduce the cost of borrowing which leads to increase in more spending in the form of investment.
• Credit view: This channel works through bank lending.
• Other asset price effects: Asset policy affects the aggregate demand.