Today, monetary policy is fairly complex and is used conjointly
with fiscal policy to trigger economic objectives by governments.
Last week, we dealt with fiscal policy. Today, we expand
on that with monetary policy.
There are several types of monetary policy: the gold standard
is still one of them, but more at the forefront are inflation
targeting, price level targeting, fixing of exchange rates,
managed float, monetary aggregates and a combination of
all or some of the above. They are also known as monetary
The mechanisms in use to implement such policies include
such things as interest rates, reserve requirements, momentary
base and discount window lending.
We have all heard the term open market operations.
In its simplest form, this refers to the ability of governments
to alter or modify the amount of currency in circulation,
also referred to as the liquidity factor. It seeks to stabilise
or control the other economic variables such as interest
rates and exchange rates.
Inflation targeting uses the Central Banks adjustment
to the interest rates at which banks lend each other overnight
in order to maintain cash flows. Such rates are then managed
for a special period by pulling money out of the system
or letting it flow in. The long-term expectation is that
the Consumer Price Index will remain at a certain value.
Price level targeting also uses overnight debt interest
rates, but is aimed at a specific CPI number. This is now
an unpopular strategy.
Monetary aggregates are also unpopular, but were not disbanded
by the FED in the US for the last several years. This policy
was used to maintain money supply at specific levels.
The gold standard is no longer in use, but it refers to
a kind of set pricing based on the value of gold; almost
a fixed exchange rate.
Among the mechanisms used in monetary policy, we focus today
on reserve requirements. This is really about demands made
by the Central Bank on the ordinary banks.
From time to time, central banks shift the amount of reserves
required from the bankers. The objective is to alter the
money supply. The reserves take the form of assets pledged
to the Central Bank, as well as the amount of cash being
held in the bank. The banks only hold on to as much cash
as is required to serve customers.
Central Bank dictates that a certain amount of cash must
form the ceiling at any point in time. If the amount of
cash that a bank can hold is reduced, the amount of money
it can lend to its customers is also reduced. This makeover
reduces the amount of money in supply for customers to borrow.
The challenge for us as individual consumers is how to insulate
ourselves from the effect of monetary and fiscal policy.