Intermediate targets - Essay Example

One of the most quoted examples of an indirect target is the money supply in an economy. Federal Reserve cannot destroy the old dollars neither it can throw a batch of new ones in the market (in practice, the Fed has all the authority to print new dollars and increase the money supply directly but it is most likely and the assumption here is that it wont do the same) (Bofinger, Reischle & Schachter, 2001). Therefore, in order to increase or decrease the money supply in the market, the process is to alter the interest rates of the economy and open market operations of buying or selling bonds.

Low interest rates coupled with the Fed’s attempt to buy the bonds in the market would increase the money supply in the market since people would take their money out of their banks to search for other investment alternatives, which can create higher returns. Furthermore, the individuals who previously had bonds now hold their asset in a form liquid form thus increasing the overall money supply in the market (Solow & Taylor, 1999; Bofinger, Reischle & Schachter, 2001) Unemployment is also an intermediate target of monetary policy.

Despite the fact that this is not the goal of monetary policy under all monetary policy but it is a major goal for most of them. In order to decrease unemployment, the monetary policy experts would try to decrease the interest rates, which would in return boost the investment from the side of the general public. More investment would lead to more job opportunities and more job opportunities, thus, reducing the overall level of unemployment (Bofinger, Reischle & Schachter, 2001). Furthermore, with decreasing interest rates, the inflation is likely to go up which would give an incentive for the producers to produce more and earn greater profits in nominal terms.

This motivates the producers to further increase the output and productivity, which leads to more employment opportunities (Solow & Taylor, 1999). Inflation Targeting In most of the states and countries where monetary policy exists, one of its prime targets is to target inflation and keep the same under the desired range, by either causing an increase or decrease in it. Since interest rate is the main tool of monetary policy for Central Bank, the inverse relationship of interest rates and inflation rates makes it clear for the general public that what the Central Bank is trying to do with the inflation (Walsh, 2003).

For example, if the inflation is above the desired or targeted level and the Federal Reserve wants to bring it down, the idea would be to raise the interest rates so that the inflation rates could drop down (Gali, 2008). Therefore, according to its definition, inflation targeting refers to the process used the Federal Reserve with which the Fed estimates, plans and set a target for future inflation and with the help of monetary policy tools makes an attempt to accomplish the same. People in the economy also get to know this target so that they could plan their savings, wages, incomes, and others in line of that future level of inflation.

Almost all the developing and developed countries in the world actively use inflation targeting since it helps in the smoothing of economic operations in the country (Bofinger, Reischle & Schachter, 2001). Inflation targeting, which is being used by many emerging economies of the world, if successfully anchored, leads to great benefits. First,