Monetary Policy Influences - Case Study Example

Introduction The economic operations of the market is always dynamic and in most instances very unpredictable. Monetary policies are checks instituted by monetary policy authorities; mostly central banks to provide control over economic aspect such as liquidity and inflation that may be otherwise hurtful to an economy. Basically central banks achieve stability by varying the amount of money available in circulation either to deal with inflation or liquidity. The various forms that money can exist in can only be balanced appropriately by having a well defined and strict monetary policy to create the balance. When it comes to international market, monetary policies ensure that a particular currency is always perceived as worth for the purchase of goods and services. Monetary policies also play the important role of controlling the amount of interest rates that banks charge on loans. Such an undertaking when left purely to be subject to economic dynamics, lenders are bond to suffer. Although monetary policies may vary from one country to another due to economic disparities, the tools used to bring about the balance in the supply of money are generally the same. These tools include: “open market reservations, reserve requirements and the discount window.” (Clinton, 2001, p.154) The general realization is that an economy would be fragile without a monitory policy to provide checks and balances in the face of economic dynamics. Inflation Inflation is described as the progressive increase in the prices of goods and services caused by a decrease in the value of money. Inflation generally occurs when the supply for money in an economy is more than demand. This situation leads to loss of value for a particular currency which ultimately leads to an increase in the amount of that particular currency required to purchase particular goods and services. There is currently a general agreement among economists that inflation rate when kept low is actually beneficial to an economy. In the past two decades countries have strived to keep their inflation rates as low as possible especially after experiencing the high inflation rates which usually lead to high rate of unemployment and high prices for goods and services. The general perception among Americans for instance, is that inflation leads to reduced standards of living and therefore the government should always prioritize to control inflation. (Romer, 1997, p. 2) Romer adds that there is also a significant correlation between inflation rates and the tax rates. Lowering of inflation rates automatically causes a reduction in tax rates. Although the complexities of economic dynamics may at some point outline that high inflation rates are beneficial when looked at from a different perspectives, it is also important to consider the effect of high inflation on common people. The essence of regulating inflation is to have control over the pricing of goods and services. Therefore, when monetary policies intervene to create a balance in the pricing of goods by regulating inflation it influences the prices of goods and other related aspects. However, economists also argue that strategy ad timing is very important in any economy. Haphhazard intervention by the central bank during high inflation may sometimes be countrproductive. This is because other variables that should be placed into perspective. Romer (1997, p.4) argues that when a country is determined so reduce inflation as a way of tackling unemployment, the country should first intiate reforms in its labor market for the undertaking to succeed. Romer therefore suggests that policy makers should have extensive knowledge of the dynamics operating in a particualr economy and have the correct monetary tools in order to effectively regulate inflation. This actully calls for loosening of stringent monetary policies so as to accommodate the variables that are in operation. Therefore, monetary policies should not only be geared towards reducing inlation without consideration of other factors. Recession Recession is an economic situation caused by a decrease in the supply of money in an economy leading to reduce purchasing power of consumers. Recession also leads to unemployment and perhaps closure and bankruptcy of industries. Recession just like inflation results from uncontrolled economic dynamics. One of the major causes of recession is uncontrolled growth where industries become over confident with the growth and therefore obtain large loans just because of it is available. On the other hand credit institutions increase the interest rates on the loans due to the increased demand. The implication is that the resultant equity becomes “non-productive assets.” (Kiran, 2010, p. 36) Recession may also be caused when a country over depends on export. In the event that a new rival country emerges or the demands of the good and services exported reduce, such a country is prone to recession because the GDP will be affected significantly. Economies that depend on the goods and service produced by a few industries are also prone to recession because in the instance that the few industries are significantly affected, the productivity of such a country will also be affected negatively. These two aspects significantly impacts on the productivity of a country and therefore directly causes recession. In such a situation the government can formulate policies that will diversify the sources of revenue for that country as a way of protecting the economy from eventualities and rival countries. However, the scenario where the government plays a significant role in establishing control is when operating in an open economy and free trade. Open economy and free trade are actually beneficial, but it is important that a country protects it companies against unnecessary debts that may arise in such a situation. For example companies can engage in uncontrolled borrowing from foreign financial institutions and this may place the company in debt. Such a situation may eventually lead to recession. (Kiran, 2010, p.123) The role played by monetary policies in such circumstances is important because it ensures that and economy is always protected from recession. However, it is also important that the monetary policies only play regulatory roles rather dictating what should happen in the economy. For instance monetary policies should not completely restrict open economy and free market just because there is the risk of businesses borrowing too much from foreign institutions. Rather the policies should ensure that the economy is open and that trade is conducted freely, but then place checks to control the situation. For instance, growth is something that every economy strives for but the promises it brings with it may lead companies to act irrationally. This happened during the credit crunch in America where financial institutions gave mortgages haphazardly without the consideration of certain important aspects with regard to economic dynamics. Many Americans were lured into taking mortgages not knowing that such a high demand for mortgages meant that the interest rates would also go up. The consequence was that most people who took the mortgages were not able to keep up with the high interest rates. The financial institutions were also adversely affected since there was no way that they could recover their money and even when they repossessed the homes, the value for the homes had already gone down significantly. In such a situation is where the government through monetary policies would have regulated the growth and restricted the amount that financial institutions could give. Economic Shocks Although it is important for the monetary institutions to come up with policies to protect an economy from economical dynamics, there is also the realization that other uncontrollable situations may also have negative effects on the economy. Such situations may be created by natural disasters that nobody has control over. For instance, Hurricane Katrina in the U.S adversely affected the economy and there was little that the government could have done to protect the occurrence of the disaster. Conclusion Monetary policies are important aspects for any economy as a way of providing checks and balances in at different levels with the aim of protecting the economy. The principle law of economics is the law of demand and supply. Although when it comes to the operations are much more complex, the general realization is that when the supply is too high hyperinflation ensues and when the supply is too low recession ensues. Therefore, there must be some way of finding some common ground where an economy can operate optimally. The responsibility of finding the common ground is given to the central bank or the monetary institution. However, the role of monetary policy should be strictly regulatory and the market forces should still be left to operate. Therefore, monetary policies should not be stringent but should be flexible enough to allow for a free and open market to thrive. Furthermore, the policies should operate with regard to the economical dynamics in a particular environment. This ensures that before a policy is implemented extensive research should be conducted to ensure that all related aspects are put into consideration. Policy maker should also have the correct tools for implementing the policies to ensure that the objectives are arrived at efficiently. Even with the realization that economic dynamics especially the ones related to monetary are sometimes complex, such considerations may improve the control that a country has over its economy. References Clinton, E. (2001). The McGraw-Hill Investor's Desk Refrence. New York: McGraw-Hill. Kiran, U. (2010). Export, Imports and Logistics Management. New Deli: Asoke K. Gosh. Romer, C. (1997). Reducing Inflation: Motivation and Strategy. Chicago: University of Chicago Press. Read More