Monetary Policy Theory

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I. What theory says about Monetary Policy? Regarding the content of the concept of “monetary policy” (Amasomma et al, (2011) it is identified as a vital tool that a government or other monetary authority implements to maintain price and exchange rate stability, it is crucial to achieve a sustainable economic growth and external viability. Monetary policy is addressed to control the growth of monetary aggregates and assists other macroeconomic policy tools to achieve macroeconomic goals of low and stable inflation, balance of payment viability, employment growth and sustainable growth (Lindsey and Wallich, 2008). It is considered that monetary policy works along with other policy tools for successful accomplishment of macroeconomic goals.…show more content…
The literature indicates four main transmission channels through which monetary authorities adjust the supply and demand for goods, services and employment, namely there are credit, interest rates, exchange rate and wealth. By using these channels, central bank influences the volume of bank credits, the exchange rate, assets price and money supply in the economy. By changing the volume of bank lending and supply of money, central banks influence the amount of credits used by other economic agents. Monetary policy designers also influence the exchange rate ad asset prices, which in return has an impact on borrowing, spending and saving decisions (Bhattacharyya, 2012). For instance, an expansionary monetary policy pulls down interest rates and thus promotes investment and consumption, thereby boosting growth and employment. At the same time, higher spending lead to higher price levels and inflationary pressure. In the contrary, if the monetary authorities restricts money supply, costs of credit will be higher, thus leading to a slowdown in borrowing and spending which results in lower growth, employment and lowering inflation rate. Furthermore, monetary policy influence on the balance of payment through the exchange rate channels and has an impact on assets prices through interest rate changes…show more content…
High and unstable inflation rates may negatively affect on savings and investment, becoming a constraint for economic growth and development and even cause political and social instability. Policymakers consider that an efficient monetary policy should have a “nominal anchor”, a reference that the central bank may employ in order to discipline their policy decisions (Leiderman and Svensson, 1995). Monetary aggregates, exchange rates and inflation rates have been implemented as nominal anchors for monetary policy in various countries. The literature on monetary policy classifies several basic strategies addressed to control inflationary processes in an economy. Mishkin (2005) outlined four strategies: (a) exchange rate pegging; (b) monetary targeting; (c) inflation targeting; (d) “just do it” strategy, which is referred to attain price stability without an explicit nominal

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