The economy of a society is more than often a complex balance of the methodology by which the central bank of the country chooses to regulate the flow of money to and from the public. To do so, a policy needs to be implemented through which the central bank can maintain control over the money that is allowed to flow to and from the public through commercial banks and any similar financial institutions that interact with or influence the economic framework of the country. This set of rules and guidelines is referred to as the monetary policy exercised by that economy.
The Monetary Policy adopted by a country serves to determine the standing of a country about its economic output and employment. By regulating the supply of money and the cost at which people can borrow that money, the monetary policy of a country controls demand for goods and services. The Monetary Policy is piloted by the Federal Reserve System, or in most cases, by the central bank. A nation needs to devise and implement a strong economic policy because a failure in the economic policy of a country results in economic contractions and a loss of faith in banking systems amongst the consumers.
Significance of the Monetary Policy
The Federal Reserve System of a country is maintained by the country’s central bank. As per the 1977 amendment in the Federal Reserve Act, the system is placed in the economy to ascertain that the maximum output can be achieved from the economy of the country and employment rates are brought to their highest extent (Federal Reserve Bank of San Francisco, 2007). The Federal Reserve System works to make sure that the prices are kept stable and a balance is maintained between inflation and deflation so as not to tip the economy. Besides this, the Monetary Policy of a country determines the safety of the banking system of the country and the stability of all the financial systems in the country to restrain the development of threats in the economy. The Monetary Policy of a country determines the stance of the Federal Reserve System towards the depository institutions and foreign financial institutions as well.
Tools used for the regulation of the Monetary Policy
There are some tools that are used to monitor and adjust the Monetary Policy of a country in order to ensure that a balance can be attained between consumer demand and the financial standing of the country (Federal Reserve Bank of New York, 2009). Further on, light shall be shed upon the four basic tools that are used by the Federal Reserve System to exercise the nation’s monetary policy.
In order to assure a successful monetary policy, the Federal Reserve System uses tools such as Interest Rates, Monetary Base, Discount Window and Reserve Requirements.
Monetary Base. The monetary base of an economy is controlled through open market operations. Government Securities are bought and sold by the Central bank to bring about the expansion or contraction of the monetary base of the economy as per requirement.
Reserve Requirements. Every Central Bank exercises certain statuary policies upon all commercial banks that they are bound to abide by. These policies incorporate statuary requirements that the banks are obliged to fulfill as well as Advance Deposit Ratios. The Central Bank uses these advance deposit ratios to regulate the amount of money that is lent to the consumer. An increase in advance deposit ratios is brought about to bring an increase in lending and a decrease is exercised to discourage lending of money.
Discount Window Lending. Discount Window Lending is used as a tool to regulate monetary policy through the fact that when commercial banks require liquidity, they more than often seek assistance from the central bank. This places the central bank in a position where it can increase the discount rates when it wishes to discourage central banks from borrowing from it. At the same time, a decrease in the discount rate can be put into effect as an encouragement for commercial banks to seek assistance from the central bank when they require liquidity.
Interest Rate. Interest Rate is no doubt one of the most commonly and deliberately used tools to ensure the application of the monetary policy of a nation. Interest Rates vary by the economic strength of a country. When desired, the money supply can be increased or decreasing by regulating the interest rates (Moeller, 2009). It is a commonly observed economic phenomenon that the slightest decrease in interest rates results in a rapid increase in the spending of money. In case a decrease in the spending and circulation of money is required, the Central Bank brings about an increasing the interest rates. Causing people to choose to save money rather than spending it.
Judging by the discussed tools used by the central bank and the influences that they have on the economy of a country, it is safe to infer that not only does the Monetary Policy of a country help to maintain the stability of the economy, but also serves to ensure that the development of the economy remains a continuous process.
Federal Reserve Bank of New York. (2009). The Federal Reserve and U.S. Monetary Policy: A Short History. Web.
Federal Reserve Bank of San Francisco. (2007). About the Fed. Web.
Moeller, T. (2009). U.S. Monetary Policy: Pushing On A String? Web.