Monetary Policy in an economy Essay Example | Topics and Well Written Essays - 2000 words

Monetary Policy in an economy - Essay Example However, the effectiveness of monetary in controlling the economy is real terms remains to be a debatable issue. If Central bank attempts to control economy by implementing monetary policy through varying interest rates, it can have some indirect impacts on the overall economic activities that might lead to problems. This paper illuminates the theoretical foundations upon which the monetary policy rests. It discusses the various methods utilised to determine and implement the monetary policy in an economy on the part of Central banks. The paper also elaborates the effectiveness of monetary policy in controlling economy and critically discusses its effectuality in meeting the intended economic ends such as controlling inflation and maintaining price stability. Developing and implementing monetary policy happens to be the most crucial responsibility of a Central Bank. Monetary policy refers to the strategies of Central Banks implemented for the purpose of controlling various economic factors such as inflation and employment etc. Bofinger, Schchter and Reischle propound that "the main aim of monetary policy is a control of final targets of the economic process (price stability, real growth, full employment), which have been set in such a way as to maximise the ultimate goal of social welfare."1 Theoretically, there are four equations that are used to evaluate the impact of money or monetary policy on the overall economy. The aggregate demand function emphasises the impact of total demand on interest rates which consequently affects inflation. The 'Philip-Lucas supply curve' or the supply function relates the total output in an economy to the rate of inflation. The third equation relates the demand of money in an economy to total expenditure as well as the interest rates. The fourth equation of monetary policy relates it to the supply of money in the economy on the part of Central Bank.2 The theoretical foundations of monetary policy rest on the fact that money plays a great role in the economy of a country. Therefore, various economic factors, in particular, the inflation rate and employment level can be controlled by an effective monetary policy. King also propounds that "money growth is higher, the higher is the inflation rate".3 The growth of money or credit in an economy goes a long way in determining the prevailing inflation rate and employment level in the long run. Monetary policy helps Central banks to achieve the goal of economic stability and inflationary targets. Mahadeva says that "Central banks have always been in the forefront of those that promote low inflation or price stability as a or the goal of monetary policy."4 It is because of the fact that controlling inflation or maintaining a desired level of prices is considered to be the important functions of monetary policy and crucial aims of a Central bank. Central banks influence the supply and growth of money in the economy by changing interest rates in order to affect the aggregate demand. Arestis and Sawyer delineate the rate of interest as, "the Central Bank rate can be viewed as the key rate on which all other interest rates are based-often explicitly so as in the case of the interest rates charged by banks on loans and paid by banks on deposits" (2004, p443). Hence the Central bank influences the supply of mon