Question

Bearing in mind the three desirable features of a policy instruments, explain how money supply and interest-rates compare as policy instruments.

Answer 1

Policy instruments means the involvement by any public authorities or by the government made in any of the economy,whether international, national or even local, which are deliberated to attain such results that comply with the public policy objectives.

The three desirable features of a policy instrument are:

• It is very simply noticeable by everyone.
• It should be capable of being influenced and can be altered easily.
• It should be connected to the goals of the policymakers.

Monetary policy leads with policies of economy which regulates size as well as development rate of money supply in the economy which came to be the most strong tool for managing macroeconomic elements such as inflation as well as unemployment. Inflation as well as liquidity can be controlled or managed in the economy with the help of this monetary policy.

Also, monetary policy is executed with the help of adjusting the rate of interests. Monetary policy is usually regulated by the central bank. By altering the discount rates, they make impact on the rate of interest. Rate of interest that is charged by the central bank to the other banks for taking loans for short-term is called discount rate. If such discount rate rises, borrowing costs also rises. Gradually, rate of interest of normal banks will also rise. As a result, borrowing cost increases and supply of money falls.

There is an interest rate called policy interest rate which was determined by the central bank which impacts the development of major economic monetary elements such as price, credit expansion, rate of exchange. Policy interest rates helps to determine the remaining interest rates prevailing in the economy. In order to perform expansive monetary policy or contractive monetary policy, central bank make use of this policy interest rate.