FACTOID # 15: A mere 0.8% of West Virginians were born in a foreign country.
 
 Home   Encyclopedia   Statistics   States A-Z   Flags   Maps   FAQ   About 
   
 
WHAT'S NEW
 

SEARCH ALL

FACTS & STATISTICS    Advanced view

Search encyclopedia, statistics and forums:

 

 

(* = Graphable)

 

 


Encyclopedia > Monetary policy
Public finance
This article is part of the series:
Finance and Taxation
Taxation
Income tax  ·   Payroll tax
CGT  ·   Stamp duty
Sales tax  ·   VAT  ·   Flat tax
Tax, tariff and trade
Tax incidence
Tax rate  ·   Proportional tax
Progressive tax  ·   Regressive tax
Tax advantage

Economic policy
Monetary policy
Central bank  ·   Money supply
Fiscal policy
Spending  ·   Deficit  ·   Debt
Trade policy
Tariff  ·   Trade agreement
Finance
Financial market
Financial market participants
Corporate  ·   Personal
Public  ·   Banking  ·   Regulation

 view  talk  edit  project

Monetary policy is the process by which the government, central bank, or monetary authority manages the supply of money, or trading in foreign exchange markets.[1] Monetary theory provides insight into how to craft optimal monetary policy. This article does not cite any references or sources. ... Image File history File linksMetadata Size of this preview: 800 × 600 pixelsFull resolution (2816 × 2112 pixel, file size: 2. ... Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. ... Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Fiscal policy Spending   Deficit   Debt Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Banking   Regulation        An income tax is a tax levied on the financial income... This article is the current Taxation Collaboration of the Month. ... For all other forms of taxation, see tax Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Fiscal policy Spending   Deficit   Debt Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Banking   Regulation        A capital gains... Stamp duty is a form of tax that is levied on documents. ... A sales tax is a consumption tax charged at the point of purchase for certain goods and services. ... Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Fiscal policy Spending   Deficit   Debt Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Banking   Regulation        Value added tax (VAT), or goods and services tax (GST), is... A flat tax, also called a proportional tax, is a system that taxes all entities in a class (typically either citizens or corporations) at the same rate (as a proportion on income), as opposed to a graduated, or progressive, scheme. ... The tax, tariff and trade laws of a political region, state or trade bloc determine which forms of consumption and production tend to be encouraged or discouraged. ... First discussed by the Physiocrats in France, tax incidence is the analysis of the effect of a particular tax on the distribution of economic welfare. ... A tax (also known as a dutyor Zakat in islamic economics) is a charge or other levy imposed on an individual or a legal entity by a state or a functional equivalent of a state (e. ... A flat tax, also called a proportional tax, is a system that taxes all entities in a class (typically either citizens or corporations) at the same rate (as a proportion of income), as opposed to a graduated, or progressive, scheme. ... Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Fiscal policy Spending   Deficit   Debt Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Banking   Regulation        A progressive tax is a tax imposed so that the effective... Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Fiscal policy Spending   Deficit   Debt Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Banking   Regulation        A regressive tax is a tax imposed so that the tax... Tax advantage refers to the economic bonus which applies to certain accounts or investments that are, by statute, tax-reduced, tax-deferred, or tax-free. ... Image File history File links This is a lossless scalable vector image. ... Image File history File links Flag_of_the_British_Virgin_Islands. ... Image File history File links This is a lossless scalable vector image. ... Image File history File links This is a lossless scalable vector image. ... Image File history File links Flag_of_Germany. ... Image File history File links Flag_of_Hong_Kong. ... Image File history File links Flag_of_India. ... Image File history File links Flag_of_Indonesia. ... Image File history File links Flag_of_the_Netherlands. ... Image File history File links Flag_of_New_Zealand. ... Image File history File links Flag_of_Peru. ... Image File history File links Flag_of_Ireland. ... Image File history File links Flag_of_Russia. ... Image File history File links Flag_of_Singapore. ... Image File history File links Flag_of_Tanzania. ... Image File history File links Flag_of_the_United_Kingdom. ... Image File history File links This is a lossless scalable vector image. ... Image File history File links This is a lossless scalable vector image. ... Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Fiscal policy Spending   Deficit   Debt Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Banking   Regulation        Comparison of tax rates around the world is a difficult and... This table lists OECD countries by total tax revenue as percentage of GDP (as of 2005). ... Not to be confused with Political economy. ... In macroeconomics, money supply (monetary aggregates, money stock) is the quantity of currency and money in bank accounts in the hands of the non-bank public available within the economy to purchase goods, services, and securities. ... Fiscal policy is the economic term that defines the set of principles and decisions of a government in setting the level of public expenditure and how that expenditure is funded. ... Government spending or government expenditure consists of government purchases, which can be financed by seigniorage (the creation of money for government funding, at a heavy price of high inflation and other possibly devastating consequences), taxes, or government borrowing. ... A budget deficit occurs when an entity (often a government) spends more money than it takes in. ... Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Fiscal policy Spending   Deficit   Debt Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Banking   Regulation        Government debt (also known as public debt or national debt) is... This article does not cite any references or sources. ... Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Fiscal policy Spending   Deficit   Debt Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Banking   Regulation        For other uses of this word, see tariff (disambiguation). ... A trade pact is a wide ranging tax, tariff and trade pact that usually also includes investment guarantees. ... Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. ... This article does not cite any references or sources. ... There are two basic financial market participant catagories, Investor vs. ... Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. ... This article does not cite any references or sources. ... For other uses, see Bank (disambiguation). ... In macroeconomics, money supply (monetary aggregates, money stock) is the quantity of currency and money in bank accounts in the hands of the non-bank public available within the economy to purchase goods, services, and securities. ... For other uses, see Money (disambiguation). ... The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. ... It has been suggested that this article or section be merged into Monetary policy. ...


Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy has the goal of raising interest rates to combat inflation (or cool an otherwise overheated economy). Monetary policy should be contrasted with fiscal policy, which refers to government borrowing, spending and taxation. Expansionary monetary policy is monetary policy that seeks to increase the size of the money supply. ... Contractionary monetary policy is monetary policy that seeks to reduce the size of the money supply. ... CIA figures for world unemployment rates, 2006 Unemployment is the state in which a person is without work, available to work, and is currently seeking work. ... In macroeconomics, a Recession is a decline in any countrys Gross Domestic Product (GDP), or negative real economic growth, for two or more successive quarters of a year. ... An interest rate is the rental price of money. ... An interest rate is the rental price of money. ... Fiscal policy is the economic term that defines the set of principles and decisions of a government in setting the level of public expenditure and how that expenditure is funded. ...

Contents

Overview

Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (in order to achieve policy goals). The beginning of monetary policy as such comes from the late 19th century, where it was used to maintain the gold standard. World GDP/capita changed very little for most of human history before the industrial revolution. ... CIA figures for world unemployment rates, 2006 Unemployment is the state in which a person is without work, available to work, and is currently seeking work. ... For other uses, see Gold standard (disambiguation). ...


A policy is referred to as contractionary if it reduces the size of the money supply or raises the interest rate. An expansionary policy increases the size of the money supply, or decreases the interest rate. Further monetary policies are described as accommodative if the interest rate set by the central monetary authority is intended to spur economic growth, neutral if it is intended to neither spur growth nor combat inflation, or tight if intended to reduce inflation. Contractionary monetary policy is monetary policy that seeks to reduce the size of the money supply. ... Expansionary monetary policy is monetary policy that seeks to increase the size of the money supply. ...


There are several monetary policy tools available to achieve these ends. Increasing interest rates by fiat, reducing the monetary base, and increasing reserve requirements all have the effect of contracting the money supply, and, if reversed, expand the money supply. Since the 1970s, monetary policy has generally been formed separately from fiscal policy. And even prior to the 1970s, the Bretton Woods system still ensured that most nations would form the two policies separately. The money base, or the monetary base is a government liability, currency and bank reserves. ... The reserve requirement (or required reserve ratio) is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. ... In macroeconomics, money supply (monetary aggregates, money stock) is the quantity of currency and money in bank accounts in the hands of the non-bank public available within the economy to purchase goods, services, and securities. ... Fiscal policy is the economic term that defines the set of principles and decisions of a government in setting the level of public expenditure and how that expenditure is funded. ... Wikipedia does not have an article with this exact name. ...


Within almost all modern nations, special institutions (such as the Bank of England, the European Central Bank, the Federal Reserve System in the United States, the Bank of Japan or Nippon Ginkō, or the Bank of Canada) exist which have the task of executing the monetary policy and often independently of the executive. In general, these institutions are called central banks and often have other responsibilities such as supervising the smooth operation of the financial system. Headquarters Coordinates , , Governor Mervyn King Central Bank of United Kingdom Currency Pound sterling ISO 4217 Code GBP Base borrowing rate 5. ... Headquarters Coordinates , , Established 1 January 1998 President Jean-Claude Trichet Central Bank of Austria, Belgium, France, Finland, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Slovenia, Spain Currency Euro ISO 4217 Code EUR Reserves €43bn directly, €338bn through the Eurosystem (including gold deposits). ... The Fed redirects here. ... The Bank of Japan has its headquarters in this building in Tokyo. ... Headquarters Established 1882 Governor Toshihiko Fukui Central Bank of  Japan Currency Japanese yen ISO 4217 Code JPY Base borrowing rate 0. ... For the defunct commercial bank, see Bank of Canada (commercial). ...


The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various credit instruments, foreign currencies or commodities. All of these purchases or sales result in more or less base currency entering or leaving market circulation. Open market operations are the means of implementing monetary policy by which a central bank controls its national money supply by buying and selling government securities, or other instruments. ...


Usually the short term goal of open market operations is to achieve a specific short term interest rate target. In other instances, however, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold. For example in the case of the USA the Federal Reserve targets the federal funds rate, the rate at which member banks lend to one another overnight. However the monetary policy of China is to target the exchange rate between the Chinese renminbi and a basket of foreign currencies. The federal funds rate is the interest rate at which private depository institutions lend balances (federal funds) at the Federal Reserve to other depository institutions overnight. ... CNY and RMB redirect here. ...


The other primary means of conducting monetary policy include: (i) Discount window lending (i.e. lender of last resort); (ii) Fractional deposit lending (i.e. changes in the reserve requirement); (iii) Moral suasion (i.e. cajoling certain market players to achieve specified outcomes); (iv) "Open mouth operations" (i.e. talking monetary policy with the market).


History of monetary policy

Monetary policy is associated with interest rate and credit. For many centuries there were only two forms of monetary policy: (i) Decisions about coinage; (ii) Decisions to print paper money to create credit. Interest rates, while now thought of as part of monetary authority, were not generally coordinated with the other forms of monetary policy. Monetary policy was seen as an executive decision, and was generally in the hands of the authority with seigniorage, or the power to coin. With the advent of larger trading networks came the ability to set the price between gold and silver, and the price of the local currency to foreign currencies. This official price could be enforced by law, even if it varied from the market price. An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... Credit as a financial term, used in such terms as credit card, refers to the granting of a loan and the creation of debt. ... Paper Money is the second album by the band Montrose. ... Seigniorage, also spelled seignorage or seigneurage, is the net revenue derived from the issuing of currency. ...


With the creation of the Bank of England in 1694, which acquired the responsibility to print notes and back them with gold, the idea of monetary policy as independent of executive action began to be established.[2] The goal of monetary policy was to maintain the value of the coinage, print notes which would trade at par to specie, and prevent coins from leaving circulation. The establishment of central banks by industrializing nations was associated then with the desire to maintain the nation's peg to the gold standard, and to trade in a narrow band with other gold back currencies. To accomplish this end, central banks as part of the gold standard began setting the interest rates that they charged, both their own borrowers, and other banks who required liquidity. The maintenance of a gold standard required almost monthly adjustments of interest rates. Headquarters Coordinates , , Governor Mervyn King Central Bank of United Kingdom Currency Pound sterling ISO 4217 Code GBP Base borrowing rate 5. ... Events February 6 - The colony Quilombo dos Palmares is destroyed. ... For other uses, see Gold standard (disambiguation). ... The currency band is a system of exchange rates by which a floating currency is backed by hard money. ...


During the 1870-1920 period the industrialized nations set up central banking systems, with one of the last being the Federal Reserve in 1913.[3] By this point the understanding of the central bank as the "lender of last resort" was understood. It was also increasingly understood that interest rates had an effect on the entire economy, in no small part because of the marginal revolution in economics, which focused on how many more, or how many fewer, people would make a decision based on a change in the economic trade-offs. It also became clear that there was a business cycle, and economic theory began understanding the relationship of interest rates to that cycle. (Nevertheless, steering a whole economy by influencing the interest rate has often been described as trying to steer an oil tanker with a canoe paddle.) The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. ... Year 1913 (MCMXIII) was a common year starting on Wednesday (link will display the full calendar) of the Gregorian calendar (or a common year starting on Tuesday of the 13-day-slower Julian calendar). ... Marginal Revolution is an economics-based weblog run by economists Tyler Cowen and Alex Tabarrok. ... // [edit] Introduction [edit] Definition If we were to take snapshots of an economy at different points in time, no two photos would look alike. ...


The advancement of monetary policy as a pseudo scientific discipline has been quite rapid in the last 150 years, and it has increased especially rapidly in the last 50 years. Monetary policy has grown from simply increasing the monetary supply enough to keep up with both population growth and economic activity. It must now take into account such diverse factors as:

A small but vocal group of people advocate for a return to the gold standard (the elimination of the dollar's fiat currency status and even of the Federal Reserve Bank). Their argument is basically that monetary policy is fraught with risk and these risks will result in drastic harm to the populace should monetary policy fail. A credit rating assesses the credit worthiness of an individual, corporation, or even a country. ... For alternative meanings, see bond (a disambiguation page). ... Ownership equity, commonly known simply as equity, also risk or liable capital, is a financial term for the difference between a companys assets and liabilities -- that is, the value that accrues to the owners (sole proprieter, partners, or shareholders). ... Derivatives traders at the Chicago Board of Trade. ... This article is about options traded in financial markets. ... For the Thoroughbred horse racing champion, see: Swaps (horse). ... In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. ...


Most economists disagree with returning to a gold standard. They argue that doing so would drastically limit the money supply, and throw away 100 years of advancement in monetary policy. The sometimes complex financial transactions that make big business (especially international business) easier and safer would be much more difficult if not impossible. Moreover, shifting risk to different people/companies that specialize in monitoring and using risk can turn any financial risk into a known dollar amount and therefore make business predictable and more profitable for everyone involved.


Trends in central banking

The central bank influences interest rates by expanding or contracting the monetary base, which consists of currency in circulation and banks' reserves on deposit at the central bank. The primary way that the central bank can affect the monetary base is by open market operations or sales and purchases of second hand government debt, or by changing the reserve requirements. If the central bank wishes to lower interest rates, it purchases government debt, thereby increasing the amount of cash in circulation or crediting banks' reserve accounts. Alternatively, it can lower the interest rate on discounts or overdrafts (basically loans to banks secured by suitable collateral, specified by the central bank). If the interest rate on such transactions is sufficiently low, commercial banks can borrow from the central bank to meet reserve requirements and use the additional liquidity to expand their balance sheets, increasing the credit available to the economy. Lowering reserve requirements has a similar effect, freeing up funds for banks to increase loans or buy other profitable assets. Open Market Operations are the means by which central banks control the liquidity of the national currency. ... The reserve requirement (or required reserve ratio) is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. ... Reserves are banks holding of deposits in accounts with their national bank (for instance, the Federal Reserve), plus currency that is physically held by banks (vault cash). ...


A central bank can only operate a truly independent monetary policy when the exchange rate is floating.[4] If the exchange rate is pegged or managed in any way, the central bank will have to purchase or sell foreign exchange. These transactions in foreign exchange will have an effect on the monetary base analogous to open market purchases and sales of government debt; if the central bank buys foreign exchange, the monetary base expands, and vice versa. But even in the case of a pure floating exchange rate, central banks and monetary authorities can at best "lean against the wind" in a world where capital is mobile. Foreign exchange has several meanings: In telecommunications, Foreign exchange service is a type of network service. ...


Accordingly, the management of the exchange rate will influence domestic monetary conditions. In order to maintain its monetary policy target, the central bank will have to sterilize or offset its foreign exchange operations. For example, if a central bank buys foreign exchange (to counteract appreciation of the exchange rate), base money will increase. Therefore, to sterilize that increase, the central bank must also sell government debt to contract the monetary base by an equal amount. It follows that turbulent activity in foreign exchange markets can cause a central bank to lose control of domestic monetary policy when it is also managing the exchange rate.


In the 1980s, many economists began to believe that making a nation's central bank independent of the rest of executive government is the best way to ensure an optimal monetary policy, and those central banks which did not have independence began to gain it. This is to avoid overt manipulation of the tools of monetary policies to effect political goals, such as re-electing the current government. Independence typically means that the members of the committee which conducts monetary policy have long, fixed terms. Obviously, this is a somewhat limited independence. Independence has not stunted a thriving crop of conspiracy theories about the true motives of a given action of monetary policy. In political science and constitutional law, the executive is the branch of government responsible for the day-to-day management of the state. ...


In the 1990s central banks began adopting formal, public inflation targets with the goal of making the outcomes, if not the process, of monetary policy more transparent. That is, a central bank may have an inflation target of 2% for a given year, and if inflation turns out to be 5%, then the central bank will typically have to submit an explanation.


The Bank of England exemplifies both these trends. It became independent of government through the Bank of England Act 1998 and adopted an inflation target of 2.5%.


The debate rages on about whether monetary policy can smooth business cycles or not. A central conjecture of Keynesian economics is that the central bank can stimulate aggregate demand in the short run, because a significant number of prices in the economy are fixed in the short run and firms will produce as many goods and services as are demanded (in the long run, however, money is neutral, as in the neoclassical model). There is also the Austrian school of economics, which includes Friedrich von Hayek and Ludwig von Mises's arguments, but most economists fall into either the Keynesian or neoclassical camps on this issue. An abstract business cycle The business cycle or economic cycle refers to the ups and downs seen somewhat simultaneously in most parts of an economy. ... Keynesian economics (pronounced kainzian, IPA ), also called Keynesianism, or Keynesian Theory, is an economic theory based on the ideas of the 20th-century British economist John Maynard Keynes. ... In economics, aggregate demand is the total demand for goods and services in the economy (Y) during a specific time period. ... Neoclassical economics refers to a general approach (a metatheory) to economics based on supply and demand which depends on individuals (or any economic agent) operating rationally, each seeking to maximize their individual utility or profit by making choices based on available information. ... The Austrian School is a school of economic thought which rejects opposing economists reliance on methods used in natural science for the study of human action, and instead bases its formalism of economics on relationships through logic or introspection called praxeology. ... Friedrich von Hayek Friedrich August von Hayek (May 8, 1899 in Vienna – March 23, 1992 in Freiburg) was an economist and social scientist of the Austrian School, noted for his defense of liberal democracy and free-market capitalism against a rising tide of socialist and collectivist thought in the mid... Ludwig Heinrich Edler von Mises (September 29, 1881 – October 10, 1973) (pronounced was a notable economist and a major influence on the modern libertarian movement. ...


Developing countries

Developing countries may have problems operating monetary policy effectively. The primary difficulty is that few developing countries have deep markets in government debt. The matter is further complicated by the difficulties in forecasting money demand and fiscal pressure to levy the inflation tax by expanding the monetary base rapidly. In general, central banks in developing countries have had a poor record in managing monetary policy. This is often because the monetary authority in a developing country is not independent of government, so good monetary policy takes a backseat to the political desires of the government or are used to pursue other non-monetary goals. For this and other reasons, developing countries that want to establish credible monetary policy may institute a currency board or adopt dollarisation. Such forms of monetary institutions thus essentially tie the hands of the government from interference and, it is hoped, that such policies will import the monetary policy of the anchor nation.


However, recent attempts at liberalising and reforming the financial markets particularly the recapitalisation of banks and other financial institutions in Nigeria and elsewhere are gradually providing the leeway required to implement monetary policy frameworks by the relevant central banks.


Types of monetary policy

In practice all types of monetary policy involve modifying the amount of base currency (M0) in circulation. This process of changing the liquidity of base currency through the open sales and purchases of (government-issued) debt and credit instruments is called open market operations. Open Market Operations are the means by which central banks control the liquidity of the national currency. ...


Constant market transactions by the monetary authority modify the supply of currency and this impacts other market variables such as short term interest rates and the exchange rate.


The distinction between the various types of monetary policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals.

Monetary Policy: Target Market Variable: Long Term Objective:
Inflation Targeting Interest rate on overnight debt A given rate of change in the CPI
Price Level Targeting Interest rate on overnight debt A specific CPI number
Monetary Aggregates The growth in money supply A given rate of change in the CPI
Fixed Exchange Rate The spot price of the currency The spot price of the currency
Gold Standard The spot price of gold Low inflation as measured by the gold price
Mixed Policy Usually interest rates Usually unemployment + CPI change

The different types of policy are also called monetary regimes, in parallel to exchange rate regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results in a relatively fixed regime towards the currency of other countries on the gold standard and a floating regime towards those that are not. Targeting inflation, the price level or other monetary aggregates implies floating exchange rate unless the management of the relevant foreign currencies is tracking the exact same variables (such as a harmonised consumer price index). The exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange market. ...


Inflation targeting

Under this policy approach the target is to keep inflation, under a particular definition such as Consumer Price Index, within a desired range. It has been suggested that this article be split into multiple articles accessible from a disambiguation page. ...


The inflation target is achieved through periodic adjustments to the Central Bank interest rate target. The interest rate used is generally the interbank rate at which banks lend to each other overnight for cash flow purposes. Depending on the country this particular interest rate might be called the cash rate or something similar. An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ... Interbank Rate or London Inter-Bank Offer Rate (LIBOR). ...


The interest rate target is maintained for a specific duration using open market operations. Typically the duration that the interest rate target is kept constant will vary between months and years. This interest rate target is usually reviewed on a monthly or quarterly basis by a policy committee.


Changes to the interest rate target are made in response to various market indicators in an attempt to forecast economic trends and in so doing keep the market on track towards achieving the defined inflation target.


This monetary policy approach was pioneered in New Zealand. It is currently used in the Eurozone, Australia, Canada, New Zealand, Norway, Poland, Sweden, South Africa, Turkey, and the United Kingdom. The Eurozone (also called Euro Area, Eurosystem or Euroland) refers to the European Union member states that have adopted the euro currency union. ...


Price level targeting

Price level targeting is similar to inflation targeting except that CPI growth in one year is offset in subsequent years such that over time the price level on aggregate does not move.


Something akin to price level targeting was tried in the 1930s by Sweden, and seems to have contributed to the relatively good performance of the Swedish economy during the Great Depression. As of 2004, no country operates monetary policy based on a price level target. The 1930s (years from 1930–1939) were described as an abrupt shift to more radical and conservative lifestyles, as countries were struggling to find a solution to the Great Depression, also known as the World Depression. ... For other uses, see The Great Depression (disambiguation). ...


Monetary aggregates

In the 1980s several countries used an approach based on a constant growth in the money supply. This approach was refined to include different classes of money and credit (M0, M1 etc). In the USA this approach to monetary policy was discontinued with the selection of Alan Greenspan as Fed Chairman. Squalltoonix (born March 6, 1926 in New York City) is an American economist and was Chairman of the Board of Governors of the Federal Reserve of the United States from 1987 to 2006. ...


This approach is also sometimes called monetarism. Monetarism is a set of views concerning the determination of national income and monetary economics. ...


Whilst most monetary policy focuses on a price signal of one form or another this approach is focused on monetary quantities.


Fixed exchange rate

This policy is based on maintaining a fixed exchange rate with a foreign currency. There are varying degrees of fixed exchange rates, which can be ranked in relation to how rigid the fixed exchange rate is with the anchor nation. A fixed exchange rate, sometimes (less commonly) called a pegged exchange rate, is a type of exchange rate regime wherein a currencys value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold. ...


Under a system of fiat fixed rates, the local government or monetary authority declares a fixed exchange rate but does not actively buy or sell currency to maintain the rate. Instead, the rate is enforced by non-convertibility measures (e.g. capital controls, import/export licenses, etc.). In this case there is a black market exchange rate where the currency trades at its market/unofficial rate.


Under a system of fixed-convertibility, currency is bought and sold by the central bank or monetary authority on a daily basis to achieve the target exchange rate. This target rate may be a fixed level or a fixed band within which the exchange rate may fluctuate until the monetary authority intervenes to buy or sell as necessary to maintain the exchange rate within the band. (In this case, the fixed exchange rate with a fixed level can be seen as a special case of the fixed exchange rate with bands where the bands are set to zero.)


Under a system of fixed exchange rates maintained by a currency board every unit of local currency must be backed by a unit of foreign currency (correcting for the exchange rate). This ensures that the local monetary base does not inflate without being backed by hard currency and eliminates any worries about a run on the local currency by those wishing to convert the local currency to the hard (anchor) currency.


Under dollarisation, foreign currency (usually the US dollar, hence the term "dollarisation") is used freely as the medium of exchange either exclusively or in parallel with local currency. This outcome can come about because the local population has lost all faith in the local currency, or it may also be a policy of the government (usually to rein in inflation and import credible monetary policy).


These policies often abdicate monetary policy to the foreign monetary authority or government as monetary policy in the pegging nation must align withe monetary policy in the anchor nation to maintain the exchange rate. The degree to which local monetary policy becomes dependent on the anchor nation depends on factors such as capital mobility, openness, credit channels and other economic factors.


See also: List of fixed currencies


Managed Float

Officially, the Indian Rupee (INR) exchange rate is supposed to be 'market determined'. In reality, the Reserve Bank of India (RBI) trades actively on the INR/USD with the purpose of controlling the volatility of the Rupee - US Dollar exchange rate - within a narrow bandwidth. ( i.e pegs it to the US Dollar ) Image File history File links Wikitext. ... “INR” redirects here. ... The RBI headquarters in Mumbai The RBI Regional Office in Mumbai The RBI heaquarters in Delhi. ...


Other rates - like the INR/Pound or the INR/JPY - have volatilities which reflect the volatilities of the US/Pound and the US/JPY respectively.


The pegged exchange rate is accompanied by an elaborate system of capital controls.


- On the current account, there are no currency conversion restrictions hindering buying or selling foreign exchange (though trade barriers do exist).


- On the capital account, "foreign institutional investors" have convertibility to bring money in and out of the country and buy securities (subject to an elaborate maze of quantitative restrictions).


- Local firms are able to take capital out of the country in order to expand globally.


- Local households have quantitative restrictions( which are being relaxed in recent times) in their ability to do global diversification . ( example while local firms can buy real estate - individuals may not). However they are able to purchase items ( mainly consumer items - say a laptop) and services reasonably freely ( there are quantitative restrictions ). Most of these transactions happen through credit cards through the internet.


Owing to an enormous expansion of the current account and the capital account, India is increasingly moving into de facto convertibility. However - it still cannot be considered a fully convertible currency.


The INR is not a highly traded currency - beyond India. It is traded by way of Forwards through inter bank transactions. ( again the US Dollar exchange rate determines the INR / other Crosses exchange rate )


As any currency traded in the international market - the INR does trade at a market determined premium / discount for the forward months.


Gold standard

Main article: Gold standard

The gold standard is a system in which the price of the national currency as measured in units of gold bars and is kept constant by the daily buying and selling of base currency to other countries and nationals. (i.e. open market operations, cf. above). The selling of gold is very important for economic growth and stability. For other uses, see Gold standard (disambiguation). ... For other uses, see Gold standard (disambiguation). ...


The gold standard might be regarded as a special case of the "Fixed Exchange Rate" policy. And the gold price might be regarded as a special type of "Commodity Price Index".


Today this type of monetary policy is not used anywhere in the world, although a form of gold standard was used widely across the world prior to 1971. For details see the Bretton Woods system. Its major advantages were simplicity and transparency. Year 1971 (MCMLXXI) was a common year starting on Friday (link will display full calendar) of the 1971 Gregorian calendar, known as the year of cyclohexanol. ... Wikipedia does not have an article with this exact name. ...


Mixed policy

In practice a mixed policy approach is most like "inflation targeting". However some consideration is also given to other goals such as economic growth, unemployment and asset bubbles.


This type of policy was used by the Federal Reserve in 1998.


Monetary policy tools

Monetary base

Monetary policy can be implemented by changing the size of the monetary base. This directly changes the total amount of money circulating in the economy. A central bank can use open market operations to change the monetary base. The central bank would buy/sell bonds in exchange for hard currency. When the central bank disburses/collects this hard currency payment, it alters the amount of currency in the economy, thus altering the monetary base. Open Market Operations are the means by which central banks control the liquidity of the national currency. ... For alternative meanings, see bond (a disambiguation page). ...


Reserve requirements

The monetary authority exerts regulatory control over banks. Monetary policy can be implemented by changing the proportion of total assets that banks must hold in reserve with the central bank. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By changing the proportion of total assets to be held as liquid cash, the Federal Reserve changes the availability of loanable funds. This acts as a change in the money supply.than


Discount window lending

Many central banks or finance ministries have the authority to lend funds to financial institutions within their country. By calling in existing loans or extending new loans, the monetary authority can directly change the size of the money supply.


Interest rates

The contraction of the monetary supply can be achieved indirectly by increasing the nominal interest rates. Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can set the discount rate, as well as achieve the desired Federal funds rate by open market operations. This rate has significant effect on other market interest rates, but there is no perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market. The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. ... Discount rate as used in finance and economics is distinct from the discount rate described below; please refer to discounting and discounts. ... The federal funds rate is the interest rate at which private depository institutions lend balances (federal funds) at the Federal Reserve to other depository institutions overnight. ... Open Market Operations are the means by which central banks control the liquidity of the national currency. ...


In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By raising the interest rate(s) under its control, a monetary authority can contract the money supply, because higher interest rates encourage savings and discourage borrowing. Both of these effects reduce the size of the money supply. In macroeconomics, money supply (monetary aggregates, money stock) is the quantity of currency and money in bank accounts in the hands of the non-bank public available within the economy to purchase goods, services, and securities. ...


Currency board

Main article: currency board

A currency board is a monetary arrangement which pegs the monetary base of a country to that of an anchor nation. As such, it essentially operates as a hard fixed exchange rate, whereby local currency in circulation is backed by foreign currency from the anchor nation at a fixed rate. Thus, to grow the local monetary base an equivalent amount of foreign currency must be held in reserves with the currency board. This limits the possibility for the local monetary authority to inflate or pursue other objectives. The principal rationales behind a currency board are three-fold: (i) To import monetary credibility of the anchor nation; (ii) To maintain a fixed exchange rate with the anchor nation; (iii) To establish credibility with the exchange rate (the currency board arrangement is the hardest form of fixed exchange rates outside of dollarisation). // A currency board is a monetary authority which is required to maintain an exchange rate with a foreign currency. ...


In theory it is possible that a country may peg the local currency to more than one foreign currency, although in practice this has never happened (and it would be a more complicated to run than a simple single-currency currency board).


The currency board in question will no longer issue fiat money but instead will only issue a set number of units of local currency for each unit of foreign currency it has in its vault. The surplus on the balance of payments of that country is reflected by higher deposits local banks hold at the central bank as well as (initially) higher deposits of the (net) exporting firms at their local banks. The growth of the domestic money supply can now be coupled to the additional deposits of the banks at the central bank that equals additional hard foreign exchange reserves in the hands of the central bank. The virtue of this system is that questions of currency stability no longer apply. The drawbacks are that the country no longer has the ability to set monetary policy according to other domestic considerations, and that the fixed exchange rate will, to a large extent, also fix a country's terms of trade, irrespective of economic differences between it and its trading partners. Fiat money or fiat currency, is money that is current or legal tender as satisfaction for money debts by government fiat, that is by law. ... This article or section does not adequately cite its references or sources. ... The balance of payments is a measure of the payments that flow from one exports and imports of goods, services, and financial capital, as well financial transfers. ... Main article deposit (bank) A deposit is a specific sum of money taken and held on account, by a bank as a service provided for its clients. ... In macroeconomics, money supply (monetary aggregates, money stock) is the quantity of currency and money in bank accounts in the hands of the non-bank public available within the economy to purchase goods, services, and securities. ... Foreign exchange reserves (also called Forex reserves) in a strict sense are only the foreign currency deposits held by central banks and monetary authorities. ...


Hong Kong operates a currency board, as does Bulgaria. Estonia established a currency board pegged to the Deutschmark in 1992 after gaining independence, and this policy is seen as a mainstay of that country's subsequent economic success (see Economy of Estonia for a detailed description of the Estonian currency board). Argentina abandoned its currency board in January 2002 after a severe recession. This emphasised the fact that currency boards are not irrevocable, and hence may be abandoned in the face of speculation by foreign exchange traders. Estonia, as a new member of the WTO, is steadily moving toward a modern market economy with increasing ties to the West, including the pegging of its currency to the euro. ... Speculation involves the buying, holding, and selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. ...


Currency boards have advantages for small, open economies which would find independent monetary policy difficult to sustain. They can also form a credible commitment to low inflation.


A gold standard is a special case of a currency board where the value of the national currency is linked to the value of gold instead of a foreign currency. For other uses, see Gold standard (disambiguation). ...


Monetary policy theory

It is important for policymakers to make credible announcements and degrade interest rates as they are non- important and irrelevant in regarding to monetary policies. If private agents (consumers and firms) believe that policymakers are committed to lowering inflation, they will anticipate future prices to be lower than otherwise (how those expectations are formed is an entirely different matter; compare for instance rational expectations with adaptive expectations). If an employee expects prices to be high in the future, he or she will draw up a wage contract with a high wage to match these prices. Hence, the expectation of lower wages is reflected in wage-setting behaviour between employees and employers (lower wages since prices are expected to be lower) and since wages are in fact lower there is no demand pull inflation because employees are receiving a smaller wage and there is no cost push inflation because employers are paying out less in wages. In economics, consumers are individuals or households that consume goods and services generated within the economy. ... For other uses, see Corporation (disambiguation). ... Rational expectations is a theory in economics originally proposed by John F. Muth (1961) and later developed by Robert E. Lucas Jr. ... In economics, adaptive expectations means that people base their expectations of what will happen in the future based on what has happened in the past. ... Demand-pull inflation arises when aggregate demand in an economy outpaces aggregate supply. ... Cost-push inflation or supply-shock inflation is a type of inflation caused by large increases in the cost of important goods or services where no suitable alternative is available. ...


However, to achieve this low level of inflation, policymakers must have credible announcements, that is, private agents must believe that these announcements will reflect actual future policy. If an announcement about low-level inflation targets is made but not believed by private agents, wage-setting will anticipate high-level inflation and so wages will be higher and inflation will rise. A high wage will increase a consumer's demand (demand pull inflation) and a firm's costs (cost push inflation), so inflation rises. Hence, if a policymaker's announcements regarding monetary policy are not credible, policy will not have the desired effect. Demand-pull inflation arises when aggregate demand in an economy outpaces aggregate supply. ... Cost-push inflation or supply-shock inflation is a type of inflation caused by large increases in the cost of important goods or services where no suitable alternative is available. ...


However, if policymakers believe that private agents anticipate low inflation, they have an incentive to adopt an expansionist monetary policy (where the marginal benefit of increasing economic output outweighs the marginal cost of inflation). However, assuming private agents have rational expectations, they know that policymakers have this incentive. Hence, private agents know that if they anticipate low inflation, an expansionist policy will be adopted that causes a rise in inflation. Therefore, (unless policymakers can make their announcement of low inflation credible), private agents expect high inflation. This anticipation is fulfilled through adaptive expectation (wage-setting behaviour) and so there is higher inflation (without the benefit of increased output). Hence, unless credible announcements can be made, expansionary monetary policy will fail. Marginal benefit is a term in economics that denotes the extra utility accrued from one additional unit of a good. ... In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. ... Rational expectations is a theory in economics originally proposed by John F. Muth (1961) and later developed by Robert E. Lucas Jr. ...


Announcements can be made credible in various ways. One is to establish an independent central bank with low inflation targets (but no output targets). Hence, private agents know that inflation will be low because it is set by an independent body. Central banks can be given incentives to meet their targets (for example, larger budgets, a wage bonus for the head of the bank) in order to increase their reputation and signal a strong commitment to a policy goal. Reputation is an important element in monetary policy implementation. But the idea of reputation should not be confused with commitment. While a central bank might have a favorable reputation due to good performance in conducting monetary policy, the same central bank might not have chosen any particular form of commitment (such as targeting a certain range for inflation). Reputation plays a crucial role in determining how much would markets believe the announcement of a particular commitment to a policy goal but both concepts should not be assimilated. Also, note that under rational expectations, it is not necessary for the policymaker to have established its reputation through past policy actions; as an example, the reputation of the head of the central bank might be derived entirely from her or his ideology, professional background, public statements, etc. In fact it has been argued (add citation to Kenneth Rogoff, 1985. "The Optimal Commitment to an Intermediate Monetary Target" in 'Quarterly Journal of Economics' #100, pp. 1169-1189) that in order to prevent some pathologies related to the time-inconsistency of monetary policy implementation (in particular excessive inflation), the head of a central bank should have a larger distaste for inflation than the rest of the economy on average. Hence the reputation of a particular central bank is not necessary tied to past performance, but rather to particular institutional arrangements that the markets can use to form inflation expectations.


Monetary policy used by various nations

  • Australia - Inflation targeting
  • Canada - Inflation targeting
  • China - Targets a currency basket
  • Eurozone - Inflation Targeting
  • Hong Kong - Currency board (fixed to US dollar)
  • New Zealand - Inflation targeting
  • Singapore - Exchange rate targeting
  • United Kingdom[5] - Inflation Targeting, although with some focus on wide issues
  • United States[6] - Mixed policy (and since the 1980s it is well fitted/described by the "Taylor rule" which shows that the Fed funds rate responds to shocks in inflation and output)

The Taylor rule is a modern monetary rule proposed by economist John B. Taylor that would stipulate exactly how much the Federal Reserve should change the interest rates in response to real divergences of real GDP from potential GDP and divergences of actual rates of inflation from a target rate...

See also

The Greenspan put was a description of the perceived attempt of then-chairman of the Federal Reserve Board, Alan Greenspan, of ensuring liquidity in capital markets by lowering interest rates if necessary. ... There are very few or no other articles that link to this one. ... A model in macroeconomics is designed to simulate the operation of a national or international economy in terms of factors including the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the general behavior of prices. ...

References

  1. ^ "Monetary Policy", Federal Reserve Board, January 3, 2006. 
  2. ^ "Bank of England founded 1694", BBC, March 31, 2006. 
  3. ^ "Federal Reserve Act", Federal Reserve Board, May 14, 2003. 
  4. ^ "Exchange Rates", The Library of Economics and Liberty, March 31, 2006. 
  5. ^ "Monetary Policy Framework", Bank Of England, 2006. 
  6. ^ "U.S. Monetary Policy: An Introduction", Federal Bank of San Francisco, 2004. 

  Results from FactBites:
 
Monetary policy - Wikipedia, the free encyclopedia (3633 words)
Monetary policy is the government or central bank process of managing money supply to achieve specific goals—such as constraining inflation, maintaining an exchange rate, achieving full employment or economic growth.
Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply.
Monetary policy was seen as an executive decision, and was generally in the hands of the authority with seniorage, or the power to coin.
Monetary policy - definition of Monetary policy in Encyclopedia (2426 words)
Monetary policy is the process of managing a nation's money supply to achieve specific goals—such as constraining inflation, achieving full employment or more well-being.
However monetary policy might entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold instead of targeting interest rates.
Their argument is bascially that monetary policy is fraught with risk and these risks will result in drastic harm to the populace should monetary policy fail.
  More results at FactBites »

 
 

COMMENTARY     


Share your thoughts, questions and commentary here
Your name
Your comments

Want to know more?
Search encyclopedia, statistics and forums:

 


Press Releases |  Feeds | Contact
The Wikipedia article included on this page is licensed under the GFDL.
Images may be subject to relevant owners' copyright.
All other elements are (c) copyright NationMaster.com 2003-5. All Rights Reserved.
Usage implies agreement with terms, 1022, m