Monetary Policies for the Global Financial Crisis - Assignment Example

? Contents Contents Introduction 2 Background Information 2 Monetary Policies: Monetary Aggregate 3 Price Level Targeting (Expansionary Monetary Policy) 4 Mixed Policy 5 Reforming Government Insurance Policies 6 Recommendation 8 References 9 Gali, J., 2008, Monetary policy, inflation, and the business cycle: an introduction to the new Keynesian framework, New York: Princeton University Press pp. 165. 9 Mishkin, F., 2007, Monetary policy strategy, Massachusetts, MIT Press pp.243. 9 Reynolds, A., 2001, The Fiscal-Monetary Policy Mix: Cato Journal, Vol. 21, Florida: Fall. Pp. 45-67. 9 Monetary Policies for the Global Financial Crisis Introduction The United States controls most of the world’s economies, meaning that an economic crisis born there will result in the disability of the entire world. The world’s drastic encounter with the Global Financial Crisis saw the demise of many financial institutions which later translated to the proclamation for steady measures to sustain many of the world’s economies. The disaster translated to a down turn in many stock markets, intrinsic topple of economies alongside a decline in all aspects of money dependent sectors of the world as a whole. The cause in the occurrence of the event was the decline in value in prime property and translating into monetary liquidity problems in the United States’ banking sector (Bordo & Michael, 2008, 17). A trace of the financial crisis takes us back to the end of 2007, when many of the securities held by banks in the United States devalued, perpetually leading to the same for the banking sectors all over the world. Background Information Characteristic of the crisis was the liquidity of banks in rendering services to their customers as their solvency had been vastly affected; leading to a very low capability to lend to customers and investors could therefore not be in a position to accomplish prospected development. The global financial crisis of 2008 was labeled the worst financial disaster since 1930’s Great Depression. It led to many adverse effects worldwide, even to the individuals who suffered mainly evictions from rental houses and evictions from mortgaged houses. Banks in the United States alone lost over a trillion dollars from dealing with toxic assets, many suffering closure and others having to lend from larger banks. The unexpected decline in the value of the world’s assets hit many banking institutions with a big bang, while many who had extended mortgages and other monetary loans could not sustain themselves with the low levels of liquidity which they encountered. The perpetual increase in the spread of the effects of the financial crisis saw other countries experiencing difficulties in sustaining their economies, much specifically those that committed much of their economy’s dominance in the western countries such as India and China. The drastic effects on the general macroeconomics of all the world’s effects of the global financial crisis obliged major monetary policy developments in economies, in an effort to protect their growth from dropping as well as the protect the individual from suffering the effects of the same. Governments had to strategize responses to protect themselves as well as device long term strategies to ensure the same does not happen to them (Gali, 2008, 165). Monetary Policies: Monetary Aggregate The purpose of the monetary aggregate policy is to increase the amount of physical money in circulation. It works towards increasing the amounts in the public so that enough of it is circulating. The effect of having a lot of circulating money is defined in many ways and it requires great scrutiny from economists. The quantity theory of money is a clear definition of the effects of applying the money aggregate monetary policy (Kenneth, R., 1985, 1175). In essence, fighting a financial crisis seeks to maximize the amount of money that is in circulation. According to the quantity theory of money, the effect of increasing the amount in circulation actually solves the problem (Bofinger, Reischle & Schachter, 2001, 326). However, the effect of the solution is only temporary and therefore a short term solution. Therefore, since the monetary policy to be employed should solely attempt work towards a long term solution, the monetary aggregate monetary policy approach is disputable and inefficient. An example of this strategy is Zimbabwe. The printing of extra money in order to fight the global financial crisis saw the drastic devaluation of the Zimbabwean currency and perpetual hyperinflation. Price Level Targeting (Expansionary Monetary Policy) This strategy works towards increasing the supply of money size, either by the Ministry of Finance or by the Central Bank. The concept behind the expansionary monetary policy is to increase the amount of money in circulation thereby increasing the liquidity of financial institutions, reducing hold-ups of money. It encourages institutions to concentrate their worth more into reserves rather than in assets (Milton, 1948, 250). The financial crisis caused a problem of reducing the flow of money since most of the institutions’ resources were engaged in illiquid forms. The expansionary monetary policy encourages the banks hold small amounts of their resources in assets forms which they can use to extend lending amounts to the public in terms of mortgages and loans, which eventually encourages increase in money supply. Benefits of expansionary monetary policy are not limited to encouraging reserves in institutions only; they also encourage discount window lending. This involves the central banks or the ministry of finance being able to extend their strictures to lending to other financial institutions, ultimately encouraging extensive risk taking into lending by financial institutions. An expansion monetary policy also works towards reducing the interest rate charged on the savings rate and discount rates; by the Federal Reserve in the United States. The idea behind this idea is that reducing the savings and the discount rates on monetary relations perpetually discourages savings by individuals, leading to a control on the federal funds rate, and perpetually on the discount rate (Jeremy, J., 2002, 388). The expansionary policy does not come without hurdles. The expansionary policy discourages investments and concentrates more on liquidizing assets and reserves so that there can be more money circulation. When the level of liquidity in an economy is high and there is little investment meaning excessive money is in circulation, the resulting would be the experiencing of inflation. It needs be implemented with cautionary measures as its sensitivity has adverse effects on the economy. The aggregate of money policy is a good idea is a good and rapid solution in an event of a financial crisis. However, this solution to the effects of a global financial crisis proves unfeasible to apply and therefore not an advisable approach to fighting financial crisis. The key attributes of a fiscal policy such as expansionary monetary policy is that the aspects and ideologies it entails are supported by the government expenditure and taxation (Heyne, Boettke, & Prychitko, 2002, 397). By employing a fiscal policy, the government achieves creation of demand in the economic environment thereby gaining price stability, favorable growth in the GDP and attaining a high employment level. It is difficult to attain the effects of employing fiscal monetary policies but since the idea of developing a monetary policy is to attain long term economic security, then it would be advisable to implement it as it leads to a decline in the level of unemployment (Mankiw, G., 1997, 297). Mixed Policy The admirable monetary policy is dedicated towards providing the most secure of all the monetary policies. The mixed policy tries to incorporate all the aspects of a favorable monetary policy while trying to encourage the benefits that come with a favorable economy. The only country in the world that practices a mixed monetary policy is the United States. A mixed market exercises the central bank to engage in open market relations in order to change the monetary base of the economy, the central bank gives financial institutions a chance to save in them, insure in them and also invest in them. Normally, the financial institutions are able to make federal reserves and are in a position to use their fractional reserves as the base money. The central bank requires that all banks make reserves in the central bank. This ensures that banks do not engage their assets in risky entrepreneurship activities which could lead to another global financial crisis. It is also put in a position to regulate the money supply thereby exercising fiscal expansionary monetary policies (Arthur & Sheffrin, 2003, 387). The central bank also bears the responsibility of lending to other banks at a discounted rate thereby encouraging a competition among banking institutions and therefore the money supply is maintained. Reforming Government Insurance Policies The government has taken the step of insuring financial institutions in order that the money they lend and the money that they invest in. Much of the cause of the financial crisis was the lack of liquidity in financial institutions, since the institutions in the United States had lent out much of its liquidity and invested in prime real estate. The fall in the world’s prime property caused the institutions to lack in liquidity, prospectively not being able to carry on with operations. Investments in these institutions were under a high risk since they all operated in property investments (Reynolds, 2001, 65). The exercise that the government took was to insure these institutions’ properties, thus being able to insure the economy as a whole. However, there needs to be reformation in the insuring of these. The policies implemented regarding insurance of money lent does not support the criteria behind insuring therefore, the government should provide proper insurance policies. The government should ensure that all policies of proper insurance are taken, including that the institutions pay proper precise premium charges necessary of an insurance scheme. This will ensure that all insured funds and investments undertakings taken by the institutions are worth insuring in as much as the return aspect is concerned (Mishkin, 2007, 243). Proper insurance also entails having proper risk insurance imposed upon the insured, giving the insurer (government) authority to regulate the activity of the investment insured. This means that the amount of money the government insures against the institutions’ investment is always under surveillance, and it is secure from the occurrence of other falls in investment markets. This way the regulation of another global financial crisis will be under control. There are success stories to support the move to monitor insured institutions. India for instance took a stance to apply restrictions to evaluate the courses of action that financial institutions engaged in before insuring them so that they did not suffer the financial crisis. As a result, the effect of the financial crisis was not rampant in India, as much as it was in England and The United States. Recommendation The best performing countries in the world practice different monetary policies. However, in the case of the United States employing the mixed monetary fund has helped them be able to come out of the financial crisis while still being in good financial position. The global financial crisis of 2008 started in the lending institutions in the United States. Still having gone through this, the mixed monetary policy aided in the upcoming of the economy as a whole again. However, there should be stronger emphasis on comprehensive insurance standards when it comes to financial institutions insuring their money in the central banks (Larch & Martins, 2009, 200). References Arthur, S. & Sheffrin, S., 2003, Economics: Principles in action, New Jersey: Pearson Prentice Hall. pp. 387. Bofinger, P., Reischle, J. & Schachter, A., 2001, Monetary policy: goals, institutions, strategies, and instrument, New York: Oxford University Press pp.326 Bordo & Michael, D., 2008, Monetary policy, history of: The New Palgrave Dictionary of Economics, 2nd ed. Pre-publication copy pp. 6-18. Gali, J., 2008, Monetary policy, inflation, and the business cycle: an introduction to the new Keynesian framework, New York: Princeton University Press pp. 165. Heyne, T., Boettke, J. & Prychitko, L. 2002: The Economic Way of Thinking, 10th ed. New Jersey: Prentice Hall pp. 392. Jeremy, J., 2002, Stocks for the Long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies, 3rd Ed. New York: McGraw-Hill, pp. 388. Kenneth, R., 1985, The Optimal Commitment to an Intermediate Monetary Target, Quarterly Journal of Economics 100, pp. 1169–1189. Larch, M. & Martins, J., 2009, Fiscal Policy Making in the European Union: An Assessment of Current Practice and Challenges, London: Routledge pp. 200. Mankiw, G., 1997, Monetary Policy, Chicago: University of Chicago Press pp. 297. Milton, F., 1948, A Monetary and Fiscal Framework for Economic Stability, American Economic Review, 38(3), pp. 245-264. Mishkin, F., 2007, Monetary policy strategy, Massachusetts, MIT Press pp.243. Reynolds, A., 2001, The Fiscal-Monetary Policy Mix: Cato Journal, Vol. 21, Florida: Fall. Pp. 45-67. Read More