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Acknowledgments: From Tariq Raza
Acknowledgments: From Tariq Raza
Acknowledgments: From Tariq Raza
While writing this case study I have assistance form many persons. I am
grateful for this assistance. I would specially like to thank the following
persons who took the time to share their ides and criticism with me.
Tariq Raza
Modern monetary policy does not involve gold to a great extent. In 1968,
the United States rescinded its promise to pay in gold and effectively
removed itself from the "gold standard". Since then, it has been the job of
the Federal Reserve to control the amount of money and credit in the U.S.
economy. I doing this, it wants to maintain the purchasing power of the U.S.
dollar and its comparative worth to other currencies. This might sound easy,
but it is a complex task in an information age where huge amounts of money
travels in electronic signals in microseconds around the world.
Table of Contents:
Topic Page No
Conclusion 23
Recommendations 24
References 25
Monetary policy
Monetary policy is one of the tools that a national Government uses to
influence its economy. Using its monetary authority to control the
supply and availability of money, a government attempts to influence
the overall level of economic activity in line with its political objectives.
Usually this goal is "macroeconomic stability" - low unemployment, low
inflation, economic growth, and a balance of external payments.
Monetary policy is usually administered by a Government appointed
"Central Bank", the Bank of Canada and the Federal Reserve Bank in
the United States.
In the 1800s, even commercial banks in Canada and the United States
issued their own banknotes, backed by their promises to pay in gold. Since
they could lend more than they had to hold in reserves to meet their
depositors demands, they actually could create money. This inevitably led to
"runs" on banks when they could not meet their depositors’ demands and
were bankrupt. The same happened to smaller countries. Even the United
States Treasury had to be rescued by JP Morgan several times during this
period. In the late 1800s and early 1900s, countries legislated their
exclusive monopoly to issue currency and banknotes. This was in response
to "financial panics" and bank insolvencies. This meant that all currency was
issued and controlled by the national governments, although they still
maintained gold reserves to support their currencies. Commercial banks still
could create money by lending more than their depositors had placed with
the bank, but they no longer had the right to issue banknotes.
The central bank uses monetary policy in two ways: that is Contractionary
monetary policy or expansionary monetary policy.
Currently, the real estate market is stagnate. Those who are fortunate
to buy property have the money to invest in the market and can pay
an additional amount. The economic game is not a zero-sum
proposition.
Higher interest-rates, and not lower rates, seems to be the only free-
market mechanism that can start to pull the economy out its
doldrums, and not massive bailouts that seem to evaporate in value
when handed over to state governments and financial institutions.
On the other hand Expansionary policy is used as a tool by the central bank
to broaden the monetary base and credit in the economy by reduction in
interest rates and increase in bond prices. The reduced interest rates attract
capital investments and increased bond prices reduces its demand and the
demand for foreign bonds to rise. The exchange rate also lowers down as a
result of fall in the demand for domestic currency and a rise in demand for
foreign currency leading currency to depreciate, resulting imports to decline
and export to accelerate.
•Price stability
Price stability, that is controlled price level, is the imperative condition for
the constant economic growth, once accomplished leads to full employment
and economic prosperity. Price stability develops investor’s confidence –
boosting investments, causing acceleration of economic activity and
achievement of full employment.
In order to attain the objectives discussed above, the central bank uses
three tools: open market operations, the discount rate and reserve
requirements.
• Open Market Operations: The most effective and major tool the central
bank uses to affect the monetary supply in the economy is open market
operations – that is, the buying and selling of government securities (usually
bonds or T-bills) by the central bank.
• The Discount Rate: the rate at which financial institutions may borrow
funds for short-term directly from the central bank.When the central bank
reduces the discount rate, financial institutions must pay to borrow from the
central bank; financial institutions become more willing to borrow, to make
more money available for lending to businesses and households at low
interest rates. This would initiate more consumption and investment
spending and generate economic activity in the economy. The reverse would
be the effect in case of increased discount rate.
• Reserve Requirements: the proportion of the total assets that banks must
hold in reserve with the central bank. Financial institutions only maintain a
small portion of their assets as cash available for immediate withdrawal; the
rest is invested in illiquid assets (like loans and mortgages). The monetary
policy can be implemented by altering the proportion of these required
reserves. Increasing the proportion of total assets to be held as liquid cash
increases the amount of money available to banks as loanable funds, thus
mean the broader monetary base in the economy, vice versa.
Changes in the real interest rates affect the demand for consumption and
savings of the people and also change the investment pattern of the
businesses.
For instance, a reduction in real interest rate lowers the cost of borrowing,
encouraging people to borrow in order to consume (durable items like,
electronic items, automobiles etc.). Moreover stimulating bank’s willingness
to lend more and investors to invest more, on the other side discourage
saving, resulting to increase spending and aggregate demand.
Lower real interest rates also make stocks and other such investments more
desirable than bonds, resulting stock prices to rise. People are likely to
increase their stock of wealth.
The increase in aggregate demand for the output boosts up the production
cycle; generating employment, as a result increase investment spending on
the existing industrial capacity. Which accelerate the consumption further
due to more incomes earned, thus attaining the multiplier effect of Keynes.
Modern monetary policy does not involve gold to a great extent. In 1968,
the United States rescinded its promise to pay in gold and effectively
removed itself from the "gold standard". Since then, it has been the job of
the Federal Reserve to control the amount of money and credit in the U.S.
economy. I doing this, it wants to maintain the purchasing power of the U.S.
dollar and its comparative worth to other currencies. This might sound easy,
but it is a complex task in an information age where huge amounts of money
travels in electronic signals in microseconds around the world.
At the other extreme, restrictive monetary policy has shown its effectiveness
with considerable force. Germany, which experienced hyperinflation during
the Weimar Republic and never forgot, has maintained a very stable
monetary regime and resulting low levels of inflation. When Chairman Paul
Volcker of the U.S. Federal Reserve applied the monetary brakes during the
high inflation 1980s, the result was an economic downturn and a large drop
in inflation. The Bank of Canada, headed by John Crow, targeted 0-3%
inflation in the early 1990s and curtailed economic activity to such an extent
that Canada actually experienced negative inflation rates in several months
for the first time since the 1930s.
Without much debate, the effectiveness of monetary policy, its timing and its
eventual impacts on the economy are not obvious. That central banks
attempt influence the economy through monetary is a given. In any event,
insights into monetary policy are very important to the investor. The
availability of money and credit are key considerations in the pricing of an
investment.
Interviews
• The financing mix of the fiscal deficit also seems uncertain. The
external financing for budget, especially the part pledged by the
Friends of Democratic Pakistan (FoDP), has mostly been elusive. Of
the Rs110 billion net external budget financing received during H1-
FY10, Rs93 billion were provided by the IMF. With an understanding
that this part of IMF money, provided in lieu of FoDP flows, is for short
term, the importance of the timing of external budgetary flows cannot
be overemphasized. Not surprisingly, therefore, government borrowing
from the SBP has been substantial in Q3-FY10. According to
provisional figures the outstanding stock of government borrowing
from SBP (on cash basis), as on 25th March 2010, stands at Rs1240
billion, which is Rs110 billion higher than the quarterly ceiling limit.
The results show that mostly developing countries fail to attain the
desired goals of monetary policy. The basic hurdles are the deep debt
burdens on government, and inflation pressures. Like, Pakistan,
although adopted tight monetary policy, stood at actual inflation rate of
7.7% (FY 2006-07), against the inflation target of 6.5% (in FY 07).
However, the monetary policy plays effective role to control the money
supply in economy in the short-run for a sustainable prosperous long-
term growth of developed countries.
References
http://www.finpipe.com/monpol.htm
http://www.cnb.cz/en/monetary_policy/instruments/
http://www.defence.pk/forums/economy-development/13561-monetary-policy.html
http://www.ehow.com/about_5245679_objectives-monetary-policy.html
Economics
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