Different Strategies to Conduct Monetary Policy - Research Paper Example

Lecturer’s and Number Submitted INTRODUCTION Monetary policy is a way by which a countries ity controls the supply of a country’s money, in many cases aiming a rate of interest for the intention of promoting economic developments and stability. The main goals often include; relatively stable prices and low unemployment cases. Monetary policy is often at times based on the relationship between the rates of interest of an economy, the cost at which money can be loaned and the total supply of money. Monetary policy is one of public intervention measure around at influencing the level and pattern of economic activity so as to achieve certain desired goals. The task of keeping the rate of inflation low is given to authority bodies such as the central bank. Monetary policy covers all the action of the bank of Canada and the government which influence the quantity, the cost and availability of money credit in the economy through open market operations and setting of banking reserve requirements. 2. DIFFERENT STRATEGIES TO CONDUCT MONETARY POLICY I. Attainment of full employment Full employment simply refers to involuntary unemployment. Monetary policy can raise the level of employment by encouraging credit availability to labor intensive section like rural agriculture and other small scale factories. Policies that lower the interest rates constitute expansionary monetary and is likely to lead to an increase in investment hence more employment opportunities. II. Price stability Economics sometime suffer from inflation and deflation; both have their effects either positively or negatively. Monetary policy helps in controlling inflation pressure. Price stability can be maintained by regulating money through tools of credit control like discount rate and minimum reserve requirement ratio. It helps in maintaining equilibrium in income and wealth inequalities. III. Economic growth expansion Money policies are put in place to ensure that more money is injected in circulation to finance developments of projects, which may in turn cause a price increase. Monetary also controls real interest rates and its effect are clearly reflected in investment. If the central government goes for an affordable and available credit policy by cutting down on the interest rates, the investment level of the economy is encouraged (Ben and Woodford 94). Increase in investment simply means higher economic developments. IV. Balance of payments equilibrium The balance of payments has two aspects, that of surplus and that of deficit. The latter reflects stringency of money and the former an excess of money. If the monetary policy succeeds in maintaining monetary equilibrium than the balance of payments, equilibrium can be achieved. V. Exchange rate stability This refers to the value of home currency expressed in terms of any foreign currency. If the exchange rate is volatile, causing rapid changes frequently, the international society might lose confidence in the economy. The monetary policy hopes to achieve and maintain relative stability in the exchange rate. The central bank tries to influence the demand for foreign exchange and also maintaining its stability. VI. Equal income distribution Fiscal policy was s used to maintain economic equality according to some economist. In recent years, it is believed that the monetary policy can also play a role in attaining that equality. It can make unique provisions for the neglect availability like small scale factories, agriculture and many more by providing for them cheaper credits for longer terms, thus assisting in reducing economic inequalities. Inflation is the increase in general level of prices of commodities in an economy over time. When prices rise, a buyer of goods and services is forced to pay more money for lesser goods and services. This simply means that inflation erodes the purchasing power of money. Inflation rates are used to measure the price of inflation. Economists argue that inflation is generally caused by a growth of the money supply. A certain rate of inflation is very inevitable and important to the economy. A high degree of inflation has effects since it will raise the cost of living of the people and most of them being low income earners. High inflation rate encourages business men to invest in nonproductive assets such as gold, jewelry, real estates and other speculative securities since imports at the time hit high prices discouraging exportation while on, the other hand, higher prices at home reduce importation of goods from the countries (Baker, Epstein and Pollin 205). Inflation, therefore, has advanced effects on balance of account and balance of payment. Inflation has different effects on the country’s economy which could be positive or negative simultaneously. Negative effects of inflation include an increase in the opportunity cost of owning money; this may certainly discourage savings and investments. Shortages of goods may occur, as well, if inflation gets rapid, the consumer may start hoarding for fear of continuous inflation in the future. Inflation also destabilizes a government in a modern economy since the economy of that particular country is uncompetitive. Moderate inflation enables adjustment of prices and wages that are a positive effect of inflation. It is argued by economists that it is easier to increase good workers salaries more than unproductive workers. Inflation also boosts growth; many times recession may be a thing for a country stuck in low inflation economy for a prolonged period thus targeting low inflation. 3. INFLATION TARGETING EXPERIENCE IN CANADA Inflation targeting refers to an economic policy that involves the coming up of monetary authorities. What makes inflation targeting different from other ways of controlling inflation is the fact that policy tools rely on a systematic evaluation rather than an arbitrary assumption. Inflation targeting has become successful with the increase of transparency and accountability of monetary policy making and generally in lowering the rate of inflation in Canada without any negative effects for the outputs. The central bank of Canada which is the bank of Canada announces publicly of specific numerical targets for inflation with a commitment of steering actual inflation by the monetary authorities to achieve the set objectives through the use of interest rates and other monetary tools. The investors are able to know beforehand what the central bank’s decision on the targets inflation rate is and are, therefore, able to make necessary changes in their investment choices. Sometimes the monetary authorities face challenges regarding monetary policies. Firstly, they must make a decision on whether to increase or decrease the money supply based on the current information as well as forecast of what the economic condition will be in the future; which are not very accurate. Consequently, there is a possibility that the misinformation causes the monetary to implement a non effective policy. Secondly, though the monetary authority is capable of reacting speedily to fluctuations in the economy, it takes a jiffy for modifications to affect the joblessness and prices in the market. Canada adopted the inflation target strategy framework in 1991, which had a less rigid institutional structure (Svensson 644). Canada’s monetary policy is based on a framework whose major components comprise of flexible exchange rate and inflation control target. Changes in major interest rates affect other interest rates, and so affect people’s spending decisions. The bank carries out monetary policy by influencing short goal interests. It succeeds in doing so by rising and lowering the target for the overnight rate. The overnight rate becomes the rate at which major financial institutions lend and borrow amongst themselves. These rates affect those of consumer loans and mortgages. The members of the bank and the government deliberate decisions to be made that will be part of the monetary policy. The initial objective of the government and the bank of Canada were to reduce inflation slowly as quantified by the total consumer price index, which ranged at about 5% in late 90s, they achieved a 2% target in 1995 until stability was reached. The 2% target was extended to 1998 to measure up how Canadian economy would perform through a full cycle which was inclusive of a period of operating at a near capacity before making a decision on the long term inflation target (Svensson 634). The target was kept at 2% because it had been successful in delivering good overall economic performance. 2001, 2008, and 2011 renewals concerning the inflation target agreements were made. So far six agreements between the bank of Canada, the government and other r monetary bodies have been written down. The primary objective is to enhance the well being of its citizens by contributing to an effective and sustained economic growth, improved standards of living and better job opportunities. The global experience concerning the economy and financial constraints underscored the Canadians inflation target structure. The inflation targeting framework, prudent fiscal policy and an effective financial system have assisted the Canadians and ensured that the country has been one of the most stable and strongly performing advanced economies in the global financial and economic emergencies. Both the bank and the government aimed at a moderate inflation rather than no inflation since normal interests rates cannot drop below zero. When the inflation rate falls below zero, the central bank will face an inability to practice its traditional tool, the policy interest rate to stimulate the economy is limited since real interest rates charged by the banks cannot fall to negative. When the interest rates are zero, many people would tend to spend more than they would invest. With an inflation goal of zero, the monetary establishments lose the chance of mobilizing the economy through negative real interest rates since real interest rates cannot fall below zero. The target range 1 to 3, and the bank of Canada money policy intends to keep it at a range of 2% (Svensson 621). This has kept the inflation rate low and stable in Canada. Another reason why the target was kept at 2% and not zero was that below zero would create difficulties in measuring inflation accurately. In Canada, the measured rate of inflation is likely to overstate the rise in the true cost of living by an approximated 0.5% per year (Manfred and Hagen 129). This clearly means if the bank targeted zero, it would logically be targeting a systematic decrease in the true cost of living annually. Thirdly, a positive rate of inflation is necessary so as to mobilize workers toward improving the economy and encourage workers in struggling industries to welcome a cut in from their nominal wages to inflation adjusted ones to avoid losing their jobs. The Canada monetary policy’s accountability is to the general community, and not only to the government through specific contracts. A key success to Canada inflation targeting strategy has been a strong and rising commitment to lucidity and the message of monetary policy strategy to the community. The bank of Canada has stressed that inflation targeting can assist dampen business set fluctuations. The inflation control has assisted in making the bank’s monetary policy actions more readily understandable to the financial sectors and the public. This target avails an understandable assessment of the effectiveness of monetary policy. One of the major benefits of a clear inflation is the purpose it plays in anchoring the expectations of the future thus leading to good decision making by the individuals, ,business men and the government its self, such decisions would probably assist in creating a non-inflationary growth in the economy. Based on experience Canada has today renewed its agreements concerning the inflation target expected to end in 31st December 2016. The agreement based on the terms that the target should remain at 2% midpoint of 1 and 3 and that it will continue to be defined on a 12 months rate of change in the total CPI (Manfred and Hagen 133). The bank aims to continue carrying out its research into advanced improvements in the monetary policy structure. 4. SUMMARY AND CONCLUSION Many other countries including New Zea land and Germany have incorporated the inflation target policy into their economic system since it is not disappointing, Despite the fact that it has got disadvantages, the minimum merits achieved from it are worth implementing it into the system. The government of Canada and the bank of Canada are hopeful that, before 2016, they will have gotten a better and more appropriate target for the years ahead. The commitment by the government and the bank to its citizens is overwhelming. They ensure the Canadians will actually continue to derive their day to day social and economic benefits from the low, stable and predictable inflation and will put their confidence in Canada’s economic prospects, in the coming years. Works Cited Baker, Dean, Gerald Epstein and Robert Pollin. Globalization and Progressive Economic Policy. Cambridge: Cambridge University Press, 1998. Ben, Bernanke and Michael Woodford. The Inflation Targeting Debate. Chicago: University of Chicago Press, 2005. Manfred, Neumann and Jurgen Von Hagen. "Does Inflation Targeting Matter?" Federal Reserve Bank of St. Louis Vol. 84 (2002): 127-148. Svensson, L. "Inflation Targeting as a Monetary Policy Rule." Journal of Monetary Economics Vol. 43 (1999): 607-654. Read More