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Poverty Trap Poverty trap is a spiraling mechanism which forces people to remain poor. It is so binding in itself that it doesn't allow the poor people to escape it. Definition: Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
The goal is to keep the economy humming along at a rate that is neither too hot nor too cold. The central bank may force up interest rates on borrowing in order to discourage spending or force down interest rates to inspire more borrowing and spending. The main weapon at its disposal is the nation's money. The central bank sets the rates it charges to loan money to the nation's banks.
When it raises or lowers its rates, all financial institutions tweak the rates they charge all of their customers, from big businesses borrowing for major projects to home buyers applying for mortgages. All of those customers are rate-sensitive. They're more likely to borrow when rates are low and put off borrowing when rates are high. Monetary policy is the control of the quantity of money available in an economy and the channels by which new money is supplied.
By managing the money supply, a central bank aims to influence macroeconomic factors including inflation , the rate of consumption, economic growth, and overall liquidity. In addition to modifying the interest rate, a central bank may buy or sell government bonds, regulate foreign exchange forex rates, and revise the amount of cash that the banks are required to maintain as reserves.
Economists, analysts, and investors eagerly await monetary policy decisions and even the minutes of meetings in which they are discussed. This is news that has a long-lasting impact on the overall economy as well as on specific industry sectors and markets. Monetary policy is formulated based on inputs from a variety of sources. The monetary authority may look at macroeconomic numbers such as gross domestic product GDP and inflation, industry and sector-specific growth rates, and associated figures.
Geopolitical developments are monitored. Oil embargos or the imposition or lifting of trade tariffs are examples of actions that can have a far-reaching impact. The central bank may also consider concerns raised by groups representing specific industries and businesses, survey results from private organizations, and inputs from other government agencies.
Monetary authorities are typically given broad policy mandates to achieve a stable rise in gross domestic product GDP , keep unemployment low, and maintain foreign exchange forex and inflation rates in a predictable range.
In addition to monetary policy, fiscal policy is an economic tool. A government may increase its borrowing and its spending in order to spur economic growth. Both monetary and fiscal tools were used lavishly in a series of government and Federal Reserve programs launched in response to the COVID pandemic.
The Federal Reserve Bank is in charge of monetary policy in the U. The Federal Reserve Fed has what is commonly referred to as a dual mandate: to achieve maximum employment while keeping inflation in check.
That means it is the Fed's responsibility to balance economic growth and inflation. In addition, it aims to keep long-term interest rates relatively low. Its core role is to be the lender of last resort , providing banks with liquidity and regulatory scrutiny in order to prevent them from failing and creating a panic. Broadly speaking, monetary policies can be categorized as either expansionary or contractionary:. If a country is facing high unemployment due to a slowdown or a recession , the monetary authority can opt for an expansionary policy aimed at increasing economic growth and expanding economic activity.
The purpose is to uplift the money supply in the economy for enhancing consumer spending and decreasing unemployment. However, it may result in inflation. The prominent tools used for this purpose involves:. Open Market Operations : The central bank purchases short-term government assets such as the US Treasury bonds or Federal assets in the open market operations Open Market Operations An Open Market Operation or OMO is merely an activity performed by the central bank to either give or take liquidity to a financial institution.
The aim of OMO is to strengthen the liquidity status of the commercial banks and also to take surplus liquidity from them. If the central bank is targeting recession, it will purchase the securities from a bank offering them. Doing this at the macro level will increase the money supply in the country.
In contrast, when it plans to reduce the cash flow, it sells the securities, reducing the reserves and availability of cash. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits.
In the situation of economic expansion, the reserve requirement is increased to decrease the money supply in the system. On the other hand, it is decreased as part of the expansionary policy.
Discount Rate : Central bank changes an interest for short-term lending to the commercial banks, which is referred to as a discount rate. The loan helps in meeting reserve requirements and short-term cash flow. If the bank increases the discount rate, it eventually permeates to other rates, including those on commercial loans. As a result, increasing commercial loan rates will discourage people from borrowing, thereby bringing down the money supply under inflation.
Amidst the coronavirus pandemic, the US Federal Reserve lowered the benchmark interest rate close to zero per cent. By implementing effective monetary policy, the Fed can maintain stable prices, thereby supporting conditions for long-term economic growth and maximum employment.
Open market operations involve the buying and selling of government securities. Open market operations are flexible, and thus, the most frequently used tool of monetary policy. The discount rate is the interest rate charged by Federal Reserve Banks to depository institutions on short-term loans. Reserve requirements are the portions of deposits that banks must maintain either in their vaults or on deposit at a Federal Reserve Bank.
The Fed uses open market operations as its primary tool to influence the supply of bank reserves. This tool consists of Federal Reserve purchases and sales of financial instruments, usually securities issued by the U. Treasury, Federal agencies and government-sponsored enterprises. The transactions are undertaken with primary dealers. When the Fed wants to reduce reserves, it sells securities and collects from those accounts.
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