Monetary Policy: Goals, Institutions, and Strategies - Research Paper Example

Central bank is a government charged with the responsibility of controlling interest rates, issuance of the new currency, regulation money supply in the economy and to oversee the operation of commercial banks in a country. Central banks also acts as the government banks bank and the government lend or borrows through it. It also acts as the lender of last resort to the financial sector during the financial crisis. It is through the central bank that the government borrows from the public through the issue of treasury bonds and bills. It lays a vital role in opening up the financial market of a country. It also has supervisory powers, aimed at limiting banks and financial intermediaries from reckless behaviour. In developed nations Central banks are independent so that they operate under rules made to help them operate in a political free management (Kurgan and Wells 387). Therefore, this paper aims at obtaining a deep analysis on the role of central bank in use and implementation of monetary policy to stabilize the economy. This will be with respect to the great depression of 1929 to early 1940s. Monetary policy is the mean through which the monetary tools of a country control the flow of money. It mostly focuses on the rate of interest with an aim of promoting economic growth and stability. It is key role is to sustain, stable prices and maintain low levels of unemployment. Monetary policy can either be expansionary of contractionary. Expansionary policies increase the supply of money in the economy while the contractionary measurers reduce the total money supply to the economy (Bofinger, Reischle and Schachter 123). Expansionary policy is theoretically used to control unemployment in a recession by lowering interest rates in the view that easy credit will motivate businesses into expanding. Contractionary policy is intended to slow inflation in a view of curbing the resulting deterioration and distortions of asset values. The Monetary policies advocated by the central bank helps in fostering the growth of financial market by encouraging open market operations. It is the most used tool by the central bank of each country to correct any economic disorder or to set the pace of a country economic growth (Bofinger, Reischle and Schachter 170). Economic depression is an economic slowdown where the gross domestic product is expected to decline at around 10%. To give rise to greet economic depression, the gross domestic product was believed to have declined by at least 33% per annum. This is the worst in history so far. Economic depression is characterized by; reduced consumption by individuals and the government, increased liquidation of the banking system or narrowing of financial market to the extent that it cannot allocate capital inflow to various sectors of the economy, high levels of unemployment expressed in two digits, insolvency of economic driving companies, a reduction in the wage rate for example, during the great economic depression it reduced sixty percent and acute shortage of money supply in the economy. Thus, depression can be defined as a recession that lasts longer and has a massive decline in business activity thus a slowdown in economic growth (Bofinger, Reischle and Schachter 213). Central bank and monetary policy with respect to the great depression of 1929 to early 1940s can be analyzed from different views. The great depression lasted for 10 years. This occurred when the shares traded in a day tripled followed by a drastic fall in price by about 24%. The great economic depression was characterized by an increased rate in unemployment which increased by 22% of the total country workforce. The total gross domestic product reduced by half as the price fell by 10%. The depression also caused farmers to lose their farms, and this made them together with the unemployed to move to urban areas in search of daily earnings, this lead to development of shanties thus creation more problems. There were massive bank failures and bankruptcies by businesses and households. Market failure was as a result of economic slowdown and poor monetary policies which was associated to have resulted to economic depression. However, market meltdown worsened the economic environment thus eroding consumer and business confidence, thus dug deeper to the economic downturn resulting to economic depression. During the time of economic depression the nominal interest rate was approximately equal to zero. This implied that the monetary policies were of no use at this particular time. Under consumption was witnessed at period’s prior years to depression when the economic progress was promising. The persisted trend of under consumption played a role in accelerating the economic downturn due the resulting an unutilized capacity. This hindered the much economic growth at the time of economic depression. The federal government in United States failed to initiate monetary policies to revive massive consumption to spur the needed economic growth. The monetary policies at this time did not provide economic incentives to households in order to improve their consumption capacity. The government also did not engage in massive public expenditure so as to boost economic growth. Federal government at that time implemented contractionary monetary policies which were not justified at this time. This was due to the fact that the economy was from recession; thus prices greatly declined. This made the value of assets decline drastically and the gross domestic product to decline by approximately 35% annually. With world devaluation of pounds there was investor’s speculation that the next target was the United States dollar this made both the federal government and private investors convert their substantial cash holding to assets (Walsh 145). This reduced the federal gold reserve ratio. Following this action by both parties it led to reduced money supply in the United States economy. This situation was worsened by an individual who felt better by hoarding cash in liquid form. This made it difficult for monetary policy to effectively impact to economic stimulation due to lack of cooperation within the economic pillars (Walsh 240). The great economic depression was also worsened by the panic of investors as a result of weak banking system in United States. Most of banks at this time suffered from financial distress calling for the need to shut down. Most banks went on liquidation, and this was as a result of government weak policies which did not support the bank with cheap lending and an increase in money supply. Individual withdrew their deposits from banks either to buy assets or for hoarding. The federal government went ahead to close down all the non performing banks. This in turn affected the invest potential of the country since; it further discouraged them from injecting into the economy. Most of the investors pulled out of the United States government this worsened the economic status of the country. Individual feared to lose their deposit in banks; thus they withdrew all their savings and opted to invest in real assets while others decided to hoard liquid cash. This action reduced the amount of money in circulation. Most of the banks were forced to close down their operation due to lack of liquid cash. It is approximated that over 9000 banks collapsed. This implied that most of the people deposits and bank loans were lost because no collateral was initially pledged. The surviving banks did not advance any loan to the individual citizens to spur development due to the fear of unknown. Thus, the great economic depression was facilitated by inefficient banking system and the witnessed inefficient monetary policies by government. The government through the central bank failed to increase the amount of money in circulation that was much needed banks to raise their liquidity position. Banking sector analysis was seen as the major a contributor towards economic depression of 1930s to early 1940s. With a crash of the stock market and the existing economic wrangles led to the reduction in production of assets which in turn the reduced the number of employed force. This impaired the purchasing power of individuals thus reducing their consumption levels. Low demand commodities made it difficult to cater their production cost, there massive accumulation of idle resources and heaping of unemployment, thus were forced to shut down. This resulted to a decline in total output of the country, this worsened the situation further. During this period, those who survived in employment had a wage cu of approximate sixty percent, implying that they had to cut their spending. As most companies begun to shut down, by 1930s the United States government introduced tariffs to protect its local companies from expounded competition in the Europe countries (McElvaine 139). They charged exorbitantly high interests against imports from European nations. This all most lead to economic hatred with European Union, giving to the fact that this union had great power to revive economic growth in United States through foreign investment the government once more failed to take advantage. This made the economy operate like a closed economy while other economies across the world were working toward integrated economies. Drought due to natural calamities across Mississippi Valley in 1930 is bound to have contributed towards economic depression (McElvaine 173). This because most of the farmers were unable to finance their loans and them even ended up selling their farms at a loss. The government failed to caution farmers in this economic situation thus forcing them to take desperate measures. Most of these farmers moved to towns to such for employment, this could not work for them because firms were retrenching and firing a worker at this time (McElvaine 197). The great economic depression in United States leads widespread hunger due to the collapse of the agricultural sector. This situation was as a result of persisted drought and the fact that farmer lost their farms, while others neglected farming as it yielded less income to the compared to other business activities. This situation by the fact that the market for agricultural products was shall and that most the agricultural industries were on their closure (McElvaine 250). The depression also resulted to increased poverty lever. Most citizens ended up living in shanties. Citizen earned little wages to keep them alive on a daily basis. They could not access fund from existing banks as they were not willing to make any commitment. This hindered them from exploiting any business opportunity which in turn blended more poverty thus slowing the economic growth. In addition the government had failed to implement poverty eradication measure as it concentrated more on economic stimulus programs. Unemployment grew by the rate of twenty five percent across the united state. Companies experienced economic difficulties and operated with the future fear of unknown, to caution cost firms retrenched workers while others reduced employment wage rate by sixty percent. This raised the level of job seekers till the beginning of Second World War where the government recruited most of the unemployed as soldiers. By virtue, that the United States had super natural power and most of the world economies were linked to its economic prosperity. When it experienced economic depression, the impact was felt to other nation across the world particularly the developing partners of the United States. Most of the developing countries whose currency was pegged to US dollar had their currencies devalued against other currencies among nations. In return the assets of these countries, significantly lost value in the world market. Investors also declined to invest in these countries because the returns of their investment remained uncertain. Most of the European nation experienced declined earning from exports since their major partner was experiencing economic slowdown. This implied that they lost revenue from trade. To retrace to the path of economic development, immediately after the economic depression united state government hired a great proportion of the unemployed to the defense forces. This was in preparation for the Second World War, as a result, the rate of unemployment reduced drastically. This helped the government to reduce the dependence ration by increasing the number of the independent people. The federal government also implemented expansionary monetary policies such as increasing the amount of money supply to the economy. This resulted to an increase in price levels, which in turn raised the total gross domestic product. Interest rates were also lowered to ensure easier access of funds by the people. This improved the amount of lending to individuals who latter invested in productive activities. This in return improved the total productivity of the country (Brussee 251). The government also developed policies to govern the banking sector particularly on lending policies and on recovery procedures. The federal government also revived the operation open market operations to spur economic growth and for effective implementation of both monetary and fiscal policies. The government also encouraged foreign investment to invest in their economy to spur it growth. The federal government also engaged in massive public expenditure to promote economic growth. Massive consumption was also encouraged to wipe out the excess capacity by that was unutilized. Therefore, economic depression can be predicted with certainty, whether it will ever occur in the future and what will be the magnitude of the depression. Owing to the increased economic integration the effect of economic depression cannot bring the world economic propensity into a stand still as it happened during the great depression. Works Cited Bofinger, Peter, Julian Reischle and Andrea Schachter. Monetary policy:goals, institutions, strategies, and instruments. Oxford: Oxford University Press, 2001. Brussee, Warren. The Great Depression of Debt: Survival Techniques for Every Investor. New Jersey: John Wiley and Sons, 2008. Krugman, Paul and Robin Wells. Macroeconomics. Richmond: Worth Publishers, 2009. McElvaine, Robert S. The Great Depression: America, 1929-1941. New York: Times Books, 1993. Walsh, Carl. Monetary theory and policy. Massachusetts: MIT Press, 2003. Read More