In light of the coming US presidential elections, hopeful candidates have been talking about issues except for one controversial topic, monetary policy. A conference is scheduled in Wyoming which will coincide with the Federal Reserve’s annual symposium wherein the organizers have invited the presidential candidates but no one seemed to be ready for a discussion.
Monetary policy has its benefits and setbacks, thus, it is important for people to understand what it is and its implications in daily living and the economy. Moreover, this can be a complicated and vague topic for those who are not familiar with what it is all about.
Definition of Monetary Policy
It is a process undertaken by the central bank, currency board or the government to control the availability of money and its supply as well as the interest rates on loans and the amount of bank reserves. Its goals include addressing the problem of unemployment, maintain balance in exchange rates and stabilize the economy.
In the United States, the Federal Reserve System which was established on December 23, 1913 is the agency which executes monetary policy which can either be expansionary or contractionary. The former increases the supply of money by lowering interest rates on loans to urge businesses to expand to reduce the number of the unemployed during recession. Conversely, the latter aims to slow the supply and even limit it to slow down inflation and prevent the devaluation of assets. In a contractionary monetary policy, interest rates are higher.
The Federal Reserve also decides how much interest rates it will impose on banks when money is borrowed from it. Conversely, banks will determine how high the interest rates will they be asking from borrowers. If the Federal Reserve set low rates for banks, consumers and commercial interest rates will also benefit from lower interest rates from banks.
Types of Monetary Policy
Inflation Targeting – This approach is used to ensure that inflation does not go over the desired limit and will be adjusted depending on current interest rates.
Price Level Targeting – This strategy targets the Consumer Price Index instead of inflation.
Monetary Aggregates – This approach is practiced by countries in relation to money supply and affects credit and classes of money.
Fixed Exchange Rate – This is the set price, usually against other currencies to ensure the U.S. dollar value is maintained within the desired perimeter.
Gold Standard – This approach aims to keep the value of money the same as the value of gold.
Economists and policy makers are divided on the effect of monetary policy on the economy and the American people. Although setting a policy can work in stabilizing the economy, there are also limitations to what it can do. This is why it is important to have pertinent information about the two sides of this approach.
List of Advantages of Monetary Policy
1. Expansionary monetary policy makes it possible for more investments come in and consumers spend more.
With the banks lowering the interest rates on mortgages and loans, more business owners will be encouraged to expand their businesses since they are more available funds to borrow with interest rates that they can afford. On the other hand, prices of commodities will be lowered and the buying public will have more reason to buy more consumer goods. In the end, companies will profit while their customers are able to afford what they need like basic commodities, property and services.
2. Lowered interest rates also lower mortgage payment rates.
Another advantage of monetary policy in relation to lowered rates is that it also affects the payments home owners need to meet for the mortgage of their homes. Reduced mortgage fees will leave home owners more money to spend. Also, they will be able to settle their monthly payments regularly. This is a win-win situation for merchandisers, creditors and property investors as well.
3. It allows the Central Bank to apply quantitative easing.
The Federal Reserve can make use of this policy to print or create more money which enables it to purchase government bonds from banks. The end result is increased cash reserves in banks and also monetary base. This also leads to reduced interest rates and more money for the bank to lend its borrowers.
4. It promotes predictability and transparency.
Supporters say that policymakers are obliged to make announcements that are believable to business owners and the consumers when it comes to the type of monetary policy to be expected in the coming months for it to be a success,
List of Disadvantages of Monetary Policy
1. Despite expansionary monetary policy, there is still no guaranteed economy recovery.
Some economists who criticize the Federal Reserve on the policy say that in times of recession, not all consumers will have confidence to spend and take advantage of low interest rates. If this is the case, then it is a disadvantage.
2. Cutting interest rates is not a guarantee.
Others also claim that even if the banks are given lower interest rates by the Central Bank when they borrow money, some banks might have the funds. If this happens, there will be insufficient funds people can borrow from them.
3. It will not be useful during global recession.
Proponents of expansionary monetary policy say that even if banks will lower interest rates and more consumers will spend money, during a global crisis, the export industry might suffer. They say that if this is the current situation, the losses of exporters are more than what businesses can earn from sales.
4. Contractionary monetary policy can discourage businesses from expansion.
Opponents claim that if the Federal Reserve will impose this policy, interest rates will increase and businesses will not be interested to expand their operations. This can lead to less production of manufacturers and higher prices. Consumers might not be able to afford goods and services. Worse, it might take a long time for these businesses to recover and eventually force them to close shop. If this continues, workers might lose their jobs.
Natalie Regoli, Esq. is the author of this post and the editor-in-chief of our blog. She received her B.A. in Economics from the University of Washington and her Masters in Law from The University of Texas School of Law. In addition to being a seasoned writer, Natalie has almost two decades of experience as a lawyer and banker. If you would like to reach out to contact Natalie, then go here to send her a message.