Read the text and give it the title.

Monetary policy is the branch of financial policy that is concerned of controlling the supply of money and credit. Monetary policy is important because of its impact on inflation and on interest rates. If a government pursues an "easy" monetary policy it means that it allows the amount of money in circulation to rise and it lets banks increase the volume of loans.

If government pursues a "tight" monetary policy, it restricts the amount of money in circulation and reduces the funds available banks for making loans.

When money is tight:

1. Interest rates rise, because commercial banks have to borrow a higher rate on the interbank market.

2. Credit falls, because people and businesses borrow less higher rates.

3. Aggregate demand falls, because people and businesses buy less, as they have less money.

4. Output falls, too, because of less consumption, firms produce less.

5. Unemployment rises, because companies are producing and selling less, and so need less labour.

6. Inflation falls, because there is less money in circulation.

7. The exchange rate will probably rise, if there is the same demand but less money, or if there is higher demand, as foreigners take advantage of the higher interest rates to invest the currency. Increasing the money supply, making more reserves available, has the opposite effects.

The amount of money in circulation and its velocity of circulation determine the average level of prices and wages. Many central banks now set money supply targets. Increasing or decreasing the money

supply, the central bank indirectly influences on interest rates, demand, output, growth, unemployment and prices. The central bank can reduce the reserves available for commercial banks by changing the reserve requirements. This reduces the amount of money that banks can create and makes the money tight or scarce.

Alternatively, the central bank can engage in what are called open- market operations, which involve selling short-term government bonds (such as three-month Treasury bills) of the commercial banks or buying them back.

And we can put up the question is monetary policy needed?

Many people believe that central banks should conduct an active interventionist monetary policy even though most countries are abandoning other forms of state intervention in their economies, such as price controls, income policies, and industrial planning. These and other forms of intervention, such as agricultural policies and state ownership of business enterprises, waste economic resources and distort markets.

Monetary policy, which represents government intervention in the marketplace for credit, exhibits the same negative effects. The time has come to challenge the need for monetary policy as practised by central bankers (often with finance ministry guidance). The financial markets, operating under appropriate tax and structural policies, will produce far greater price stability and smoother economic growth than central bankers can.

Some people still believe that controlled growth of the money supply will minimise inflation. In fact, the quantity of money in the industrialised nations today is essentially demand-driven. Currency, a key component of the money supply, is demand-driven when people can easily exchange unneeded currency for interest-bearing financial assets, such as bank deposits and bonds. Currency-driven inflations occur only when governments finance their deficits by paying the obligations in currency that cannot be converted easily into other assets.

Bank deposits, the main component of the money supply in industrialised countries, are demand-driven as well. This demand reflects the willingness of individuals and businesses to provide credit to the economy in which they operate, versus investing in real assets or moving funds to other countries.

Reserve requirements on bank deposits, still a favoured monetary policy tool of some central bankers, do not restrict bank lending.

As a practical matter, monetary policy in the industrialised world today essentially takes the form of announced official rates for lending to banks and central bank "steering" of short-term rates.

The credit markets do not differ from other markets. Interest, like any other price, should clear the market at a rate that balances supply with demand.

 

Exercises

 

Answer the questions.

1. What is the monetary policy?

2. Why is monetary policy so important?

3. What happens when a country pursues a “tight” or an “easy” monetary policy?

4. What are the peculiarities of the situation when money is tight?

5. What does determine the average level of prices and wages?

6. How can central bank influence on interest rate, demand, output, etc.?

7. What are the negative effects of monetary policy?

8. Is it true that controlled growth of the money supply will minimise inflation?

9. When does currency-driven inflation occur?

10. What does demand reflect?

11. What practical matter does monetary policy have?

12. Is monetary policy needed?