When a central bank speaks publicly about monetary policy, it usually focuses on the interest rates it would like to see, rather than on any specific amount of money although the desired interest rates may need to be achieved through changes in the money supply. Reference Ireland, Peter N. Most economists would agree that in the long run, output—usually measured by gross domestic product GDP —is fixed, so any changes in the money supply only cause prices to change.
Some argue that credit easing moves monetary policy too close to industrial policy, with the central bank ensuring the flow of finance to particular parts of the market. The one people traditionally focus on is the interest rate channel. When the central bank puts money into the system by buying or borrowing securities, colloquially called loosening policy, the rate declines.
When rates can go no lower After the onset of the global financial crisis incentral banks worldwide cut policy rates sharply—in some cases to zero—exhausting the potential for cuts.
For instance, the Fed set up a special facility to buy commercial paper very short-term corporate debt to ensure that businesses had continued access to working capital. 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 keep with it.
Such a countercyclical policy would lead to the desired expansion of output and employmentbut, because it entails an increase in the money supply, would also result in an increase in prices. If the central bank tightens, for example, borrowing costs rise, consumers are less likely to buy things they would normally finance—such as houses or cars—and businesses are less likely to invest in new equipment, software, or buildings.
As an economy gets closer to producing at full capacity, increasing demand will put pressure on input costs, including wages. To overcome the problem of time inconsistency, some economists suggested that policymakers should commit to a rule that removes full discretion in adjusting monetary policy.
The central bank expects that changes in the policy rate will feed through to all the other interest rates that are relevant in the economy.
Nonetheless, they have found unconventional ways to continue easing policy. Fiscal policy —taxing and spending—is another, and governments have used it extensively during the recent global crisis.
During the recent crisis, many specific credit markets became blocked, and the result was that the interest rate channel did not work. Monetary policymakers who were less independent of the government would find it in their interest to promise low inflation to keep down inflation expectations among consumers and businesses.
But however it may appear, it generally boils down to adjusting the supply of money in the economy to achieve some combination of inflation and output stabilization. Long-term contracts will then build in more modest wage and price increases over time, which in turn will keep actual inflation low.
But this is not the end of the story. In turn, GDP shrinks. However, it typically takes time to legislate tax and spending changes, and once such changes have become law, they are politically difficult to reverse. That expands the money supply.
Blume Houndmills, United Kingdom: Indeed, even central banks, like the ECB, that target only inflation would generally admit that they also pay attention to stabilizing output and keeping the economy near full employment.
This is usually done through open-market operations, in which short-term government debt is exchanged with the private sector. Monetary policy has an important additional effect on inflation through expectations—the self-fulfilling component of inflation.
Conducting monetary policy How does a central bank go about changing monetary policy? But in the short run, because prices and wages usually do not adjust immediately, changes in the money supply can affect the actual production of goods and services.
Transmission mechanisms Changing monetary policy has important effects on aggregate demand, and thus on both output and prices. This reduced level of economic activity would be consistent with lower inflation because lower demand usually means lower prices.
While many central banks have experimented over the years with explicit targets for money growth, such targets have become much less common, because the correlation between money and prices is harder to gauge than it once was. Monetary policy is not the only tool for managing aggregate demand for goods and services.
If policymakers hike interest rates and communicate that further hikes are coming, this may convince the public that policymakers are serious about keeping inflation under control.
There are a number of ways in which policy actions get transmitted to the real economy Ireland, This belief stems from academic research, some 30 years ago, that emphasized the problem of time inconsistency. Durlauf and Lawrence E.
A rise in interest rates also tends to reduce the net worth of businesses and individuals—the so-called balance sheet channel—making it tougher for them to qualify for loans at any interest rate, thus reducing spending and price pressures.
Monetary policy is often that countercyclical tool of choice. The evidence suggests that central bank independence is indeed associated with lower and more stable inflation. In practice, though, committing credibly to a possibly complicated rule proved difficult.
A rate hike also makes banks less profitable in general and thus less willing to lend—the bank lending channel.James Poterba, president James Poterba is President of the National Bureau of Economic Research.
He is also the Mitsui Professor of Economics at M.I.T.
Monetary policy has lived under many guises. But however it may appear, it generally boils down to adjusting the supply of money in the economy to achieve some combination of inflation and output stabilization.
Most economists would agree that in the long run, output—usually measured by gross domestic product (GDP)—is fixed, so any changes in the money supply only cause prices to change.Download