Question

Explain the process as well as the direction of causation, of a(n) [Expansinary, Restrictive ] monetary policy? Use complete sentences and 500 to 700 words. Please explain in details Use economic theories and terminologies.

Answer 1

Monetary policy is a action and communication of central bank manage the use of monetary instruments such as interest rates, money supply, loans, bonds, and mortgages, credit, cash, checks, and money market mutual funds. It increases liquidity to create economic growth specifically at times of recession by adopting some monetary tools which tend the increase the money supply and lower interest rates, which stimulate aggregate demand in the economy. The central bank’s monetary Policy Department (MPD) assists the Governor to formulate the monetary policy. Monetary policy includes drafting, announcing, implementing the plan taken by the central bank, currency board, and other competent monetary authority of a country. The Financial Markets Operations Department (FMOD) analyses the monetary policy with the help of day to day liquidity management operations.
In expansionary monetary policy central bank stimulates the economy that increases the money supply, lowers interest rates, and increases aggregate demand. Reduce interest rates stimulate investment and consumption spending, causing the original aggregate demand curve to shift right. Central bank take causation in expansionary monetary policies are by knowing how much to do, and when to stop requires sophisticated analysis and involves substantial uncertainties. Expanding the economy more can cause side effects such as high inflation or an overheated economy. Expansionary policy involves an effective transfer of purchasing power and wealth from the earlier recipients to the later recipients of the new money.
Restrictive monetary policy reduces the amount of money and credit that banks can lend, lowers the money supply by making loans, credit cards and mortgages more expensive. That constricts demand, which slows economic growth and inflation. Banks restrict liquidity. Restrictive monetary policy lowers the money supply by making loans, credit cards and mortgages more expensive and by increasing interest rate. Central bank take necessary causation in restrictive monetary policies is by knowing how much to do and when to stop because it slower the economic growth. Restrictive monetary policy Increase interest rate, discourage borrowing for investment and consumption spending, and cause the original demand curve to shift left.
Monetary policy must be countercyclical. It should maintain the counterbalance in business cycles of economic downturns and upswings. Central bank should loosen monetary policy when a recession has caused unemployment to increase and tighten it when inflation threatens.
Money supply is the main driver of monetary theory of economic activity. Monetary theory states that if a nation's supply of money increases, economic activity will rise, too, and vice versa. Monetary theory focuses on maintaining stable prices in the economy, promoting full employment, and achieving steady growth in gross domestic product (GDP). Monetary theory works well when the economy follows a smooth course, with stable prices and adequate access to capital for corporations and individuals. Monetary theory posits that governments, unlike regular households, should not tighten their spending in an under performing economy. Instead, it encourages them to spend freely, running up a deficit to fix a nation’s problems. It is the job of the central bank, FRB to control the money supply by considering Reserve ratio, Discount rate, Open market operations.