MANAGERIAL ECONOMICS

Assignment - I
Monetary Policy as a Tool For Achieving
Economic Objectives

Monetary Policy as a Tool For Achieving

Economic Objectives

MEANING
Monetary policy is the process by which the monetary authority of a country controls the supply
of money, often targeting a rate of interest for the purpose of promoting economic growth and
stability.
The official goals usually include relatively stable prices and
low unemployment. Monetary economics provides insight into how to craft optimal monetary
policy.
Monetary policy is referred to as either being expansionary or contractionary, where an
expansionary policy increases the total supply of money in the economy more rapidly than usual,
and contractionary policy expands the money supply more slowly than usual or even shrinks it.
Expansionary policy is traditionally used to try to combat unemployment in a recession by
lowering interest rates in the hope that easy credit will entice businesses into expanding.
Contractionary policy is intended to slow inflation in order to avoid the resulting distortions and
deterioration of asset values.
Monetary policy differs from fiscal policy, which refers to taxation, government spending,
and associated borrowing

GOALS OF MONETARY POLICY

Inflation
Inflation results in a drop in the value of money. Inflation can have a negative impact on
savings accounts and investments because of reduced values in currency. As money loses
value, so do wages, pensions and investments. Prices go up, making daily living harder.
Fighting inflation has been the main traditional goal of monetary policy.

Stability
One of the most important goals of monetary policy is stabilizing currency values. The
benefit is that investors and businesses can rely on the value of the currency and,
therefore, can make intelligent decisions about long-term investments.

Interest Rates
Keeping interest rates stable is another important goal. A balance must be struck between
the desires of investors to see a large return on investment with higher interest rates with

borrowers who want low interest rates on loans. Striking a balance between these two
interests is important for monetary policy because both promote economic growth,
savings and investment.

Balance of Payments
If a specific currency gains in value relative to its neighbors, goods from that country,
when sold abroad, will be more expensive. As the value of the currency falls, the
competitiveness of goods from that economy becomes more competitive abroad. Again, a
balance must be maintained between these two poles: a strong currency that speaks to
low inflation at home, and a weak currency that might boost international sales. As a
specific currency falls in value, the debts incurred in that currency also fall in value.
Therefore, a currency that is too strong might make international debts that much higher.

HOW MONETARY POLICY AFFECTS ECONOMIC

OBJECTIVES.
Control Inflation
One of the primary impacts of monetary policy is on inflation. The goal of monetary
policy is to control inflation, or the value of currency, through changes in monetary
policy tools. When inflation rises, the central bank typically raises interest rates. High
inflation makes the costs of goods higher. Central banks want to keep inflation low to
keep the prices of goods stable relative to the value of the currency.

Interest Rates
Monetary policy directly impacts interest rates. The central bank raises or lowers the
prime rate, or interest rate the central bank loans money to other banks, as a tool to
impact the economy. These actions have a trickledown effect on the interest rates charged
on loans, credit cards and any other financial vehicle that is tied to the prime rate.

Business Cycles
Business is cyclic in nature and goes through periods of expansion and contraction.
Monetary policy attempts to minimize the speed and severity of these expansions and
contractions to maintain steady growth or decrease a negative contraction. The goal is to
keep an economy on a slow, but steady growth pattern to prevent recessions during
periods of contraction.

Spending

Monetary policy impacts the amount of money spent in an economy. When a central bank
decreases interest rates, more money is typically spent in an economy. This increase in
spending can equate to better overall health for an economy. Likewise, when interest
rates are increased, spending declines, this could curtail inflation.

Employment
Employment levels relate to the health of an economy. When inflation is low and an
economy is stable or in an expansionary phase, employment levels are higher than when
inflation is high and an economy is in a contraction phase. Changes in monetary policy
that maintain economic stability and minimize inflation, tend to keep unemployment low