Term Paper: Goals of a Monetary Policy

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[. . .] Which in return lead towards maximization of output. And this maximization of output lead towards high rates of employment. The high rates of employment in return elevate the living standards to a higher rate. (Cambazo-lu & Karaalp, 2012)

In the short run, countries may face various phases of boom and recessions. The central bank can control the rate of inflation and can elevate the rates of employment by controlling the money supply. This control over the rates of inflation and the rates of employment is maintained in a short run and does not remain in effect in the long run. (Cambazo-lu & Karaalp, 2012)

2.3. Economic Stability and Growth

The monetary policy plays an important role in stabilizing and triggering economic growth. The monetary policy's goal to achieve economic stability can be distorted by the pressure of accomplishing other goals of the policy. The first step taken by the monetary policy to attain sustainable economic growth is to maintain stable prices throughout the economy. As these stable prices can prevent the value of money from decreasing and contribute towards maintaining the purchasing power of the money. (How Does Monetary Policy Affect Economic Growth?, 2001)

The second step that the policy takes is to cut down the interest rates to a lower level. As the rate of interest is the cost of borrowing, lower rates of interest encourage the businesses to borrow from sufficient fud units (SFUs). The businesses then invest these borrowed funds in productive operations. These investments lead towards higher Gross Domestic Product (GDP) and ultimately higher standards of living and a stable economic growth. (How Does Monetary Policy Affect Economic Growth?, 2001)

Stable economic growth makes a country sound and powerful. It enhances its trade and commerce activities and directs an attractive amount of Foreign Direct Investment (FDI) towards it. It elevates the living standards of the citizens of that country and lead towards maximized investment, output and employment in that country. (How Does Monetary Policy Affect Economic Growth?, 2001)

2.4. Moderated Interest Rates

The supply of money has a direct impact on the interest rates. The increase in money supply would always lead towards a decrease in the rates of interest, whereas, a decrease in the money supply would always lead towards an increase in the rates of interest. The supply of money has the above discussed impact on the interest rates at least in the short run and the medium run. (Mishkin, 1983)

Interest rates can have a direct impact on the investment and consumer expenditure. In addition to that, rates of interest can also have an influential impact on the valuation of capital. Decline in the interest rates can have an expansionary effect on all the three variables, whereas, an increase in the rates of interest can have a contractionary impact on all the three variables. (Mishkin, 1983)

But both high increase and decrease in the rates of interest can be harmful for the economy as a constant increase in the rates of interest can lead towards elevated rates of inflation. Whereas, a constant decline in the rates of interest can lead towards elevated rates of deflation. It is, thus, a critical element of the mechanism of a monetary policy to maintain moderate or stable rates of interest in order to stabilize the economic growth and prices as well so that the individuals and the businesses can enjoy maximum economic welfare. (Mishkin, 1983)

2.5. Stable Financial Markets

The stability of financial markets is another key goal of the monetary policies. Healthy and stable financial markets lead towards a healthy economy. Financial markets consist of financial intermediaries that play an important role in channeling the funds from Sufficient Fund Units (SFUs) to Deficit Fund Units (DFUs). (Driffill, J. et al., 2005)

If the financial markets are not stable then there is a flaw in the proper channeling of funds. Those with productive ideas do not get the appropriate amount of funds and hence there is an evident decrease in the investments. In addition to that, if the funds are channeled through financial intermediaries then there is a decline in the chances of frauds and there is also a decrease in the transaction costs, that is the time and money required to channel funds. So the instability and inefficiency of financial markets can lead towards high rates of frauds and high transaction costs. (Driffill, J. et al., 2005)

Apart from that, financial markets also facilitate the individuals to invest their money in sound portfolios of assets. They decrease the risk associated with investments as they convert the high risk assets into low risk assets by constituting a variety of pools of assets that have both high and low risk assets. If the financial markets are stable then they can perform all these functions efficiently and can have an expansionary impact on investments, savings, Gross Domestic Product (GDP), employment and overall economic growth. (Driffill, J. et al., 2005)

Central banks usually try to stabilize financial markets by smoothing the rates of interest. That is, by decreasing the fluctuations in the rates of interest in the short run. As the unnecessary fluctuations in the interests can have a negative impact on the functioning of financial institutions, specially on the functioning and operations of different commercial banks. (Driffill, J. et al., 2005)

As banks usually borrow on short terms and lend on long terms. In addition to that, if due to unnecessary fluctuations in the rates of interest a bank fails to pay off its borrowed amount then this failure can have a negative impact on the functioning of all the other financial institutions and on the stability of financial market as well. The central banks, therefore, try to maintain stability in the financial markets by maintaining stability in the interest rates. (Driffill, J. et al., 2005)

2.6. Stable Foreign Exchange Markets

The foreign exchange market provides a platform through which the currency of one country is exchanged for the currency of any other country. The exchange rate for the countries is determined and the foreign exchange transactions are then completed at a physical level. (Bordo, M. et al., 2012)

The central banks aim to maintain stability in the foreign exchange markets through appropriate policies. This is because the decline in the exchange rate of a country leads towards the decline in the value of money and consequently towards an increase in the rates of inflation. (Bordo, M. et al., 2012)

Whereas, an increase in the foreign exchange rate lead towards a decreased in the demand of local goods as the consumers find imported goods less expensive. This lead towards the decline in the exports of the country and an increase in the imports of the country. The decline in exports and an increase in imports has a negative impact on the balance of payments and the country thus has to suffer a trade deficit. (Bordo, M. et al., 2012)

The central banks try to maintain stability in the foreign exchange markets as the stable foreign exchange markets lead towards lower rates of inflation and better trade performance. Both these variables can have a positive impact on the overall economic growth of the country which is the broad goal of almost every monetary policy. (Bordo, M. et al., 2012)

While designing a monetary policy the central banks and the responisible officials shall ensure that the policy works well in the long run and the medium run. As the short run impacts of the policies are not everlasting but the changes in the monetary policy can have a prominent impact on an economy in the long run. So the targets for a monetary policy should be designed in a way that they have a positive impact on the prices, interest rates, economic growth, financial markets, foreign exchange markets and employment in the long run. And they may contribute towards overall economic growth of the country in the long run. (Macfarlane, 2012)

3. Policies to Achieve Macroeconomic Goals in Developing Countries

Economic growth is not a naturally occurring phenomena. Over a period of time, the world has seen some countries witnessed real growth in economic terms. Whereas, the poverty and economic conditions in some countries kept on deteriorating. During the past years some countries have achieved great economic stability and have decreased the rates of poverty and inflation to a great extent. All these conditions prevail in different countries due to their policy frameworks and structures. (Macroeconomic stability, inclusive growth and employment, 2012)

Developing countries face a number of problems in achieving the key goals of the monetary policy. The major problem prevailing in the low income or developing countries is that the central banks of such countries are not independent and therefore, they cannot take corrective measures to target economic growth without justifying their actions to other parties. In addition to that, the political pressure in developing countries is greater than that in developed countries so the central banks have… [END OF PREVIEW]

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