Question

Is Monetary Policy an effective long term solution to solve a country's economic problems?

Explain your position in up to 250 words.

250 words please

Answer 1

Monetary policy, policies used by governments to control economic activity, in particular by controlling liquidity and credit flows and by adjusting interest rates. The Fed uses three key mechanisms to regulate money supply: open-market operations, discount rates and reserve requirements. The first is the most important, by far. The Fed or a central bank affects the money supply and interest rates by purchasing or selling government securities (usually bonds). For instance, if the Fed is purchasing government securities, it pays with a check drawn on itself. This activity generates money in the form of extra deposits from commercial banks selling the securities.

The second instrument is the discount rate, the interest rate that the Fed (or a central bank) is lending to commercial banks at. An increase in the discount rate reduces the amount of loans that banks make. The discount rate is used as a proxy in most countries, so that a increase in the discount rate is usually accompanied by a similar change in the interest rates paid by commercial banks.

The third tool regards changes in reserve requirements. By regulation, commercial banks retain a specific percentage of their deposits and allow reserves with the Fed (or a central bank). They are held either as non-interest-bearing assets or in cash form. The reserve requirement serves as a brake on commercial banks ' lending operations: by raising or reducing the reserve-ratio requirement, the Fed will control the amount of liquidity available for lending and, thus, the money supply.