Monetary policy
I. Introduction ( Cường )
1. Definition
Monetary policy - also known as monetary circulation policy - is the
process of managing the money supply of the central bank to achieve goals such
as economic stability and growth, increasing GDP, controlling inflation,
stabilizing exchange rates, reducing unemployment, etc. In managing the
macroeconomy, monetary policy is an important and effective tool of the
government to promote the national economy.
2. The importance of monetary policy
Monetary policy is one of the most important tools for the state to
manage and operate the economy. This policy contributes to stabilizing the
macroeconomy, controlling inflation, stabilizing consumer prices, stabilizing the
gold market, foreign exchange market, etc., gradually helping to restore and
promote the economy. In addition, this is also a tool for the State Bank to
control the activities of commercial banks and credit institutions nationwide.
II. Monetary policy in action ( Sơn )
1. Conducting monetary policy
How does a central bank go about changing monetary policy? The basic
approach is simply to change the size of the money supply. This is usually done
through open-market operations, in which short-term government debt is
exchanged with the private sector. If the Fed, for example, buys or borrows
Treasury bills from commercial banks, the central bank will add cash to the
accounts, called reserves, that banks are required to keep with it. That expands
the money supply. By contrast, if the Fed sells or lends treasury securities to
banks, the payment it receives in exchange will reduce the money supply.
2. Expansionary monetary policy
This approach is used to stimulate economic activity during periods of
recession or economic slowdown. The key mechanisms include:
- Lowering Interest Rates: Reduced borrowing costs encourage individuals
and businesses to take loans for consumption and investment, thereby
increasing demand.
- Increasing Money Supply: Central banks achieve this by buying
government securities or reducing reserve requirements for banks,
injecting liquidity into the economy.
- Quantitative Easing: Large-scale asset purchases by central banks to
boost money circulation.
The aim is to increase aggregate demand, create jobs, and boost economic
growth.
However, excessive use can lead to inflation if demand outpaces supply.
3. Contractionary Monetary Policy
This strategy slows economic growth to control inflation and prevent an
overheating economy. Its tools include:
- Raising Interest Rates: Higher rates make borrowing more expensive,
reducing consumer spending and business investments.
- Decreasing Money Supply: This can be done by selling government
securities or raising reserve requirements for banks.
- Tightening Credit Conditions: Ensuring stricter access to credit limits
excessive economic activity.
While this policy helps control inflation, it can lead to reduced economic output
and higher unemployment if over-applied.
Both policies are crucial for economic stability, but they require careful
implementation to balance growth and inflation risks effectively.
III. Challenges and considerations ( Thọ )
Challenges:
1.Time Lags:
There is a lag between changes to monetary policy and its effect on
economic activity and inflation because households and businesses take time to
adjust their behaviour. Some estimates suggest that it takes between one and two
years for monetary policy to have its maximum effect.
2.Inflation Expectations:
Workers expect higher future inflation, they may demand higher wages to
compensate for the expected loss of purchasing power. These behaviors,
sometimes referred to as ‘inflationary sentiment’, can contribute to an increase
in the actual rate of inflation so that inflationary expectations become
self-fulfilling.
3.Financial Stability:
Monetary policy can promote financial stability and improve household
welfare. We consider a macro model with a financial sector in which banks do
not actively issue equity, output and growth depend on the aggregate level of
bank equity, and equilibrium is inefficient. Monetary policy rules responding to
the financial sector are ex-ante stabilizing because their effects on risk premia
decrease the likelihood of crises and boost leverage during downturns. Stability
gains from monetary policy increase welfare whenever macroprudential policy
is poorly targeted. If macroprudential policy is sufficiently well-targeted to
promote financial stability, then monetary policy should not target financial
stability.
Considerations: ( Đăng )
1.Economic Growth:
Monetary policies can help economic growth. For example, lowering
interest rates on loans will encourage spending and investment by consumers
and businesses, and can boost stock prices. But lower rates can also lead to
inflation, which undermines the effectiveness of low rates.
2.Financial Stability:
In the wake of the economic crises, central banks have introduced a
variety of stimulus policies to provide liquidity and maintain the flow of credit.
To ease tensions in currency and bond markets, many emerging market central
banks have resorted to foreign exchange interventions and, for the first time,
asset purchase programs. More recently, in response to rising inflation, central
banks around the world have tightened monetary policy by raising interest rates.
The above shows that central banks play an important role in minimizing the
harmful ripple effects of failures through close supervision of systemically
important payment and clearing systems.
3.Price Stability: ( Vũ )
Central banks use monetary policy to manage economic fluctuations and
achieve price stability, which means that inflation is low and stable. Central
banks in many advanced economies set explicit inflation targets. Many
developing countries also are moving to inflation targeting. Central banks
conduct monetary policy by adjusting the supply of money, usually through
buying or selling securities in the open market. Open market operations affect
short-term interest rates, which in turn influence longer-term rates and economic
activity. When central banks lower interest rates, monetary policy is easing.
When they raise interest rates, monetary policy is tightening.
IV. Conclusion
● Monetary policy is a powerful tool for managing an economy.
● Central banks must carefully balance competing objectives.
● Understanding monetary policy is crucial for individuals and businesses.
