Pros and cons of monetary policy? | 5 Answers from Research papers (2024)

FAQs

What are the good effects of monetary policy? ›

Monetary policy employs tools used by central bankers to keep a nation's economy stable while limiting inflation and unemployment. Expansionary monetary policy stimulates a receding economy and contractionary monetary policy slows down an inflationary economy.

Monetary policy consists of the steps the central bank of a nation can take in order to regulate the nation's money supply. For instance, a central bank might reduce interest rates during a recession in order to make loans more readily available to other banks and thus stimulate economic recovery.

The Fed uses three main instruments in regulating the money supply: open-market operations, the discount rate, and reserve requirements. The first is by far the most important. By buying or selling government securities (usually bonds), the Fed—or a central bank—affects the money supply and interest rates.

Overall, Modern Monetary Theory has its advantages and disadvantages. While it could provide increased funding for public programs and allow governments to be more responsive to their citizens' needs, it could also lead to inflation, a lack of fiscal discipline, and increased political influence over the economy.

Government interventions include price-fixing, licensing, quotas, and industrial subsidies. Benefits of a market economy include increased efficiency, production, and innovation. Disadvantages include monopolies, no government intervention, poor working conditions, and unemployment.

If the central bank tightens, for example, borrowing costs rise, consumers are less likely to buy things they would normally finance—such as houses or cars—and businesses are less likely to invest in new equipment, software, or buildings.

A major advantage of monetary rules over discretion is that when the Fed is systematic and follows policy based on a rule, financial market participants, households, and businesses can better understand what the Fed is doing and take that into account in forming expectations.

The effectiveness of monetary policy is dependent upon the transmission channel. Credit channel and liquidity channel transmit any monetary policy actions in the financial system. In economies with a less developed financial system, the credit channel dominates the liquidity channel.

What Is Monetary Policy? Central banks use monetary policy to manage the supply of money in a country's economy. With monetary policy, a central bank increases or decreases the amount of currency and credit in circulation, in a continuing effort to keep inflation, growth and employment on track.

Central banks use monetary policy to manage economic fluctuations and achieve price stability, which means that inflation is low and stable. Central banks in many advanced economies set explicit inflation targets.

What is an example of a monetary policy? ›

Tools of Monetary Policy

For example, if a central bank increases the discount rate, the cost of borrowing for the banks increases. Subsequently, the banks will increase the interest rate they charge their customers. Thus, the cost of borrowing in the economy will increase, and the money supply will decrease.

Disadvantages of Monetary Policy

Technical limitations: Interest rates can only be lowered nominally to 0%, which limits the bank's use of this policy tool when interest rates are already low. Keeping rates very low for prolonged periods of time can lead to a liquidity trap.

Monetary policy can provide numerous advantages for the economy, such as smoothing business cycles, anchoring inflation expectations, enhancing efficiency and innovation, and supporting fiscal policy.

There are two main goals of monetary policy. This first goal is that everyone who wants a job can find one. This is called maximum employment. The second goal is stable prices.

However, there are downsides, such as loss of sovereignty and control of its currency, the potential for a conflicting monetary policy with its own needs, and the fact that member countries with problems will seek bailouts.

The rate of inflation chosen as the policy objective has to be consistent with the desired rate of output and employment growth. An inappropriate choice can lead to losses of macroeconomic welfare. Monetary authorities have to continually contend with the short-run trade-off between growth and inflation.

Overall, contractionary fiscal policy can be an effective tool for stabilizing the economy and controlling inflation. However, it can also have negative consequences, such as a reduction in economic growth and increased unemployment.