¶ … Goals of a Monetary Policy
Finance.
Monetary policy is a complex framework of money demand and money supply. It cannot be framed easily as the formulating of the monetary policy for the state is a massive responsibility for the central bank of that state because the composers of the monetary policy are very well aware of the fact that there little mistake can cost the state and its economic development a lot. (Labonte, 2006)
Monetary policy can be defined as a set of policies that are related to the supply of money. As the sole agency which is responsible for the money supply in a state is the central bank of that state, therefore, monetary policy can also be defined as the rules, policies or statements of the central bank of a state, especially of its board of directors, that have an impact on the aggregate demand and national spending. (Labonte, 2006)
Specific attention is being paid to the announcements, of the Chairman of the central bank and the board of directors, that relate to the monetary policy by the financial press and markets. This is because the monetary policy has a direct impact on the aggregate demand and through aggregate demand; it can influence the Gross Domestic Product (GDP) of a state.the monetary policy of a state can have an influential impact on other variables such as real foreign exchange rates, unemployment, interest rates, and output etcetera. (Labonte, 2006)
Though all the above mentioned variables are the important ones, but the impact of monetary policy on these variables usually occurs in the short run. The monetary policy, however, has a long-term impact on the rate of inflation. An increase in the money supply can lead towards a decrease in interest rates which will lead towards an increase in investment. This increase in investment will lead towards an increase in Gross Domestic Product (GDP) and this will consequently increase employment and economic stability but all this will happen in the short run. (Labonte, 2006)
In the long run, however, an increase in the money supply would lead towards a rapid increase in the rate of inflation. So the positive effects of the rapid growth of money are evident only in the short run and in the long run the economy is left to handle with extreme rates of inflation. In the economies where high rates of inflation are common, the rapid growth of money does not stimulate any positive effect instead it causes the rates of inflation to go higher. (Labonte, 2006)
2. Goals of a Monetary Policy
According to the Federal Reserve Act, 'the Board of Governors and the Federal Open Market Committee should seek to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.' It can be said that stable prices in the long run can trigger sustainable economic growth and employment and they can also lead towards moderate interest rates. (The Federal Reserve System: Purposes and Functions, 2005)
When the prices of goods, services and labor are stable then this indicates that the prices are not distorted by the changes in the rates of inflation. Such stable prices provide a clear way for the allocation of resources and thus the resource allocation can be made more efficient. This in return can lead towards a higher standard of living. (The Federal Reserve System: Purposes and Functions, 2005)
In addition to that, stable prices also lead towards an increase in the rate of savings and generation of capital. This because the risk of loss in the value of assets, due to inflation, is decreased and the households are encouraged to save more, and businesses and investors are also encouraged to invest in different projects. (The Federal Reserve System: Purposes and Functions, 2005)
In addition to that, employees of the Federal Reserve and other central banks also include economic growth, stability of financial markets and the stability of foreign exchange markets in the key goals of a monetary policy. (Conduct of Monetary Policy: Goals and Targets, 2003)
2.1. Price Stability
Price stability is the primary and the most widely accepted goal of the monetary policy. The most important reason for maintaining price stability is that inflation can cause a country to suffer a lot both in economic and social terms. This can be proved by the fact that price stability has a negative relation with the economic growth in the long run. Throughout the world, the central banks usually make long-term price stability their primary goal. (Gaspar & Abreu, 1999)
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