Monetary policy is all about the measures taken by a central bank of a country to regulate its money supply and interest rate to control inflation and stabilize its currency. The monetary policy is one of the mechanisms other than the fiscal policy the governments can use to influence the valuable cost of money and the monetary spending by consumers and enterprises. Objectively, a monetary policy has a role of impacting the performance of an economy, which can be reflected by the inflation rate, economic output, and unemployment rates of a country.
In the American government, monetary policy is under the control of the Federal Reserve System which essentially carries out some operations that influence interest rates. Its role has broadened far beyond as a controller of specific industries but rather, the overall rate of economic growth, uphold high levels of employment and stabilize prices by the use of the monetary policy which manages the supply of money. American economic policy has quite changed since the 1990s depression. The government has continued to formulate monetary policies which will promote a sustainable growth and stabilize prices of which it has not been an easy task. From the early 1990s, the American economic output was most of the time contracting, but from the early 2000 its economic expansion increased as a result of prudent monetary policy. Save to the 2008 economic recession which almost eroded the successes of the monetary policy. Hence, the need to evaluate the successes of the United States monetary policy in the last 10 years which will be reflected by the use of different tools to control the monetary policy. (Monetary and fiscal policy Para. 1-4).
Operation of the monetary policy
The American federal government uses various tools to evaluate its monetary policy; open market reserve, reserve ratio and federal fund rates are the tools used to control its money supply. The federal fund rate and discount rates have an effect on the monetary policy. When the Financial institutions are able to borrow loans from the Federal Reserve as a result of lower discount rate charged by the Federal Reserve, the amount of money in circulation is increased. Where as, if other financial renders discount rate which are lower than that of the federal government, these financial institutions will shift their borrowing source to them. Thus, increasing or decreasing the discount rate, the Federal Reserve System is able to encourage or discourage borrowing to regulate the amount of income available to banks for making loans.
Secondly, the American Federal Reserve System has been using the percentage of deposits any financial institutions can hold as a reserve by the use of the required reserve ratio as a tool of controlling its monetary supply. The Federal Reserve commands the required reserve ratio. If the ratio is lowered, the financial institutions are obligated to maintain a lesser percentage than reserves so as to loan more to their clients, thus increasing the circulation of money. When the Federal Reserve raises the reserve ratio, the financial institutions drain their system due to decreased money circulation in the economy.
Lastly the Federal Reserve uses the open market operations to drain or increase the money circulation in its economy. Items such as T-Bills and bonds are sold to commercial banks through auction to drain money out of the economy, at the same time buying these T-bills and bonds by the Federal Reserve from the commercial banks will increase the money circulation in the economy. When the Federal Reserve purchases bonds from the financial institutions and the public, the financial institution will have a positive reserve in assets which will in-tern increase the lending abilities of the financial institutions. Where as, when the Federal Reserve put up for sale its bond to financial institutions, it will have a positive securities and a negative reserve in assets resulting to a reduced lending abilities of the financial institutions.
These three monetary policy evaluation tools influenced the American money circulation in its economy whose successful applications can be reflected by its sustained money supply, economic output, Inflation Rate, and employment Rate (Monetary policy Para.1- 4).
Sustained money supply
In the 1999 and 2000 fiscal yeas, The American Federal Reserve System held debt securities given by the private financial institutions as national debt to reinforce its reserve notes. But during this time, its national debt declined significantly causing panic among the bankers. This forced the federal government to look for alternative ways to back the Federal Reserve notes rather than the use of government debts. In 2004 fiscal year, the United States central bank started to use assets to partially replace the national debt as a base to back its reserve notes. By extensive use of assets price information and the risk free rate the Federal Reserve notes have been able to maintain the money supply.
To enhance the transfer of funds, the federal government used the expansionary open market operations to create additional debt in form of bank deposits in the financial institutions. This was backed by charging interest by the lenders as a cost of borrowing the money. Were it not to the borrowings open market operations the vast money circulation could have not been achieved. Hence, the rise or fall of the circulation of money in an economy matches to the growth or decline in national debt (Federal Reserve Bank of Sun Francisco Para. 1-16).The success of this federal reserve monetary policy is witnessed for lessening anxiety in the commercial sector following the world trade center bombing by the terrorist and the physical damage to the financial markets during the same time. The current increase in the Federal Reserve money supply was as a result of the Federal Reserve decision to buy securities and lend loans to banks ease credit.
The other success the monetary policy has been able to achieve is the interbank lending of the surplus reserves. But the rate at which these financial institutions charge each other for the money borrowed is influenced by the markets forces with the help of the three monetary policy evaluation tools. The monetary policy decisions taken by the Federal Reserve to add reserves to the financial institutions structure have encouraged interbank lending at lesser interest rates hence, stimulating growth in money supply which translate to an economic growth.
One of the primary goals of the monetary policy is to control inflation, since when the inflation rises, the costs of goods rises relative to the decrease in value of that currency. Inflation is another aspect the united state monetary policy has been trying to control. Monetary inflation is a raise in the money circulation in the economy. When there is a rapid rise in money circulation over a short period of tome, there is a decline in the purchasing power of money. When there is a monetary inflation, the financial lenders lose because they will be repaid with money of less value compared to when it was borrowed. At the same time, the Savers will also lose their value of money because of the monetary inflation. The money they will save today will not be able to buy as much when they need to spend it in the future.
Higher monetary inflation is not a good indication because it deters economic growth but still too low inflation rates close to zero are also not good. This is because if inflation rate is too low, then short-term interest rates are also expected to decline to zero which might put the government in a satiation which it might not able to lower short-term interest rates if need be to stimulate the economy or even cause deflation. But through the monetary policy the Federal Reserve has been able to be control the inflation rate favorably (Roger Para. 3-10).
Year after year, a change in the United States consumer price index has been representing its inflation rate. Its ability to maintain a low inflation rate between 2 and 3 percent in the last ten years is an indication of the success of the monetary policy undertaken by the Federal Reserve. When the inflation is high, the prices of products increases which intern raises the doubt about what the inflation in the upcoming time will be. This uncertainty will hamper the economic growth as it will add an inflation risk premium to long term interest rates, hence altering the economic decisions by randomly raising or lowering after tax rates of different economic activities. In addition, unexpected inflation is likely to share out wealth between the financial lenders and the borrowers. For instance, when loans have a preset rate, unexpected high inflation disadvantages the financial lenders to borrowers, since inflation lowers the actual burden to the borrowers payments whose nominal price is preset.
The level of employment rate is used as a measure of a nation’s economic status, and therefore as a gauge of the achievements of applied economic policies. When there is a fall in inflation and the economy is stable, unemployment levels tend to be lower than when inflation is high and economic growth is on a slow down. Monetary policy changes will maintain a positive economic performance by minimizing inflation and keep employment levels high as the economy can sustain. To stimulate employment rates, mostly it depends on other factors such as the fiscal policy, technology and people preferences for saving, risk, and work effort rather than monetary policy for a sustained and increased employment rates. So, maximum sustainable employment rates means that the above factors should be steady in the long run.
In the latest times, the American economy has witnesses an economic slowdown which has resulted to a high unemployment rates. To curb this unemployment, the Federal Reserve come up with a short term monetary policy which decreased the interest rates and increased spending to stimulate the economy and hence increasing the employment rates in the short term. For instance, when the American economy and employment went below its optimal levels as a result of recession in the year 2008/2009, the Federal Reserve stimulated the economy momentarily to curb unemployment levels which was on the rise. This short-term economic stimulation was aimed at creating employment opportunities temporarily as the economy was restructuring to its normal growth.
Monetary policy is one of the mechanisms the United State federal government used to trigger its economic growth by controlling money supply into economic activities objectively to attain macroeconomic stability in the long-run. The Federal Reserve increased money supply has effected its long-term economic growth by increasing economic output, increasing labor forces, and buildup of its capital. The high levels of money supply in the economy has stimulated investment and industrial consumer demand since any measure that exhausts money supply out of the economy acts as a deterrent to decreased spending and investments; thus lowing the economic growth.
After United States experienced a stable economic growth for quite some time, it economy began to slow down towards the end of 2000 fiscal year. The policy makers were caught unexpectedly with the economic slowdown as they tried to moderate the economic growth. Though areas of economic weak point were apparent, the strong fundamentals of keeping high levels of employment and keeping inflation as low as possible were to be prioritized to avoid total recession through the exception tax stimulus package. Monetary policy acted as an effective tool to combat recession. The Federal Reserve acted boldly by reducing interest rates and it may need to take extra bold steps to lower its interest rates further, to encourage spending if the economy is to fully get back on track.
A long run economic growth requires investment in the present to help increase productivity, which then increases the wages and family incomes hence, a tax stimulus package will only have a modest effect on the current short-term economic slow down. The American government has moderately cut down its tax to effectively caution the low earners in the short term during the economic slow down which took place in the year 2008/2009. The recent rise in consumer confidence in the United States economic recovery is a sign of success of the monetary policy put into place as the employment levels are almost back to track which is a key to economic development (Neil Para.1-9).
In conclusion, the primary purpose of creating the monetary policy was to control money supply. The Federal Reserve has used successfully the policy to regulate money supply in the economy whose effect can be reflected by its inflation, employment and the economic status; low Inflation rate, high employment levels and economic growth are positive result of the monetary policy which the Federal Reserve applied. Through the Federal Reserve rate, the monetary policy has enabled the financial institutions to receive liquidity from the Federal Reserve so as to meet their short- term needs resulting from day-to-day fluctuations in reserve demand and supply in form of deposits and withdrawals.
Practically, monetary policy affects the economic and financial decisions made to all of us starting from the consumers, creditors to financiers hence, the need for the control of the rise and fall of inflation as a result of high circulation or under circulation of money. The monetary policy has been one of the tools that the American government used to regulate its money supply so as to influence the overall level of economic growth. By moderating the money supply in to various economic activities, low unemployment rates, low inflation and economic growth has been achieved.
However the success of the monetary policy can be seen, still there lays a major problem in formulating the effects of monetary policy on economic growth and inflation. This is because of the monetary policymaker’s base their actions on a huge sum of data which at times makes it difficult to interpret its effects.
The incredibly strong economic performance of the United States from the year 2000 to year ending 2007 before the economic recession in the year 2008/2009 which hit not only America but most of the world largest economies should provide a lead to future policy choices. American Federal Reserve having found a strong and most effective policy which can fight off recession, it should be used adequately by the rest of the nations to tackle the current economic slowdown which is a short term and cyclical hence requiring the short term measures.
To avoid speculation on market stability, the federal monetary policy should be more transparent. Since sometimes the policy choices appear sensibly straightforward, policy makers regularly face certain uncertainties concerning the Federal Reserve balance sheet. If its balance sheet status is not accessible, the position of the economy at any time is not fully known. This forces the policy makers to rely on estimates of economic variables to make an appropriate course of policy. Hence the need for the provision of daily performance of the Federal Reserve balance sheet to the policy makers.
Finally, attention should be given to both monetary policy and fiscal policy since each one of them works best at different situations. To deal with short term solutions to employment, inflation and economic stimulation, monetary policy works best whereas the fiscal policy work best for a sustained employments, low inflation and a sustained economic growth.
Federal Reserve Bank of Sun Francisco: About the FED 2010. Web.
Neil, Martin. “Domestic Monetary Policy, Technology, and Economic Growth.” 2001. Web.
Roger, Ferguson. “Economic Growth.” 2006. Web.