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Difficulties Faced by Central Banks in Operating Monetary Policy - Coursework Example

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The paper "Difficulties Faced by Central Banks in Operating Monetary Policy" states that apart from the various shortcomings of monetary policy, there are various other factors, which are also contributing to the difficulties faced by the central banks in operating monetary policy. …
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Difficulties Faced by Central Banks in Operating Monetary Policy
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Download file to see previous pages There are two steps, which the central bank takes to operate monetary policy. In the first step, the policymakers decide the policy objectives that they want to attain and in the second step, the policymakers decide the process of manipulation of the tools of monetary policy. There are primarily three tools of monetary policy, which are used by the central bank including open market operations, discount policy and reserve requirements. The most commonly used tool of monetary policy is open market operation whereas; the discount loans only make up two to three percent of it. The reserves requirement ratio is not frequently used because it can destabilize the economy. Therefore, the central bank usually relies on open market operations.
In recent years, the importance of monetary policy has increased because of the diminishing role of fiscal policy in the stabilisation efforts made for economy. During the period from the 1960s to 1980s, the governments of various countries were facing problems in handling inflation and unemployment through fiscal policy. Therefore, the monetary policy appeared as an effective way to fight against unemployment and inflation. However, various limitations to monetary policy have been always creating problems for the central banks in operating monetary policy.
During the period of the 1930s, when the U.S economy was facing an economic downturn, FED encountered very serious problems in operating monetary policy. In order to combat the economic downturn, the monetary policy of the FED was aimed to increase the amount of money in circulation to cut off the interest rates. After implementing the policy, the interest rates reached to zero and FED did not have any other option. This situation is also known as a liquidity trap and Japan also encountered such as situation during the late 1990s. It means, the central banks have been always facing problems while dealing with monetary policy.
Actually, there are different reasons because of which the central banks face difficulties in operating monetary policy. For example, in a more liberal environment, where the capital moves freely, the operation of monetary policy becomes very complicated. ...Download file to see next pages Read More
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