• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Monetary policy effect on Macroeconomics

Extracts from this document...


Monetary policy effect on Macroeconomics Monetary policy is the method by which the government, central bank, or monetary authority controls the supply of money, or trading foreign exchange markets. This policy is usually called either an expansionary policy, or a contractionary policy. An expansionary policy multiplies the total supply of money in the economy, and a contractionary policy diminishes the total supply. Expansionary policy is used to tackle unemployment in an economic decline by lowering interest rates, while contractionary policy has the goal of elevating interest rates to fight inflation. Monetary policy reposes on the relationship between the rates of interest in an economy and the total dispense of money. Monetary policy uses a diversity of tools to dominate exchange rates with other currencies and unemployment. This is done in order to influence outcomes like economic growth and inflation. A policy is called contractionary if it diminishes the size of the money supply or increases the interest rate. An expansionary policy raises the size of the money supply, or lowers the interest rate. Monetary policies are accommodative if the interest rate is intended to stimulate economic growth, neutral if it is intended to neither encourage growth nor fight inflation, or tight if its aim is to reduce inflation. ...read more.


Fundamentally, the Federal Reserve controls only one thing; the volume of bank reserves held by U.S. banks. To control bank reserves, the Federal Reserve buys or sells Treasury bills in the open market, either taking reserves away from banks or giving banks reserves. On that, there is basically no choice. Measuring GDP is complicated but the calculation can be done in one of two ways: either by adding up what everyone earned in one year (income approach), or by adding what everyone spent (expenditure method). Both measures should arrive at approximately the same total. A significant change in GDP, up or down, usually has a significant effect on the stock market. It's not hard to understand why: a bad economy usually means lower profits for companies, which in turn means a decrease in stock prices. Growth lessens the burden of scarcity (McConnell & Brue, 2008). Monetary Policy effect on Unemployment When the economy is healthy, you will generally see low unemployment and wage increase as businesses demand labor to meet the economy. Monetary policy has two basic goals: to promote "maximum" output and employment and to promote "stable" prices (Money 2008). Since the Fed cannot control inflation or affect output and employment directly it makes and impression indirectly, through raising or lowering short-term interest rates. ...read more.


However, unemployment rates in the intermediate range are usually difficult to interpret (Money 2008). There are two types of inflation: Demand-pull Inflation and Cost- push Inflation. Interest rates Monetary policy causes an increase in bond prices and a decrease in interest rates. A free market rate of interest is a composite of three factors: the originally rate of interest, the risk premium, and the price inflation or deflation (rare since 1933) premium (North 2006). Conclusion It is amazing at how little we know about where our money goes or comes from. Many people are content with the simple knowledge that our money goes in our banks of choice. However, things are not as simple as they seem. Our money goes somewhere and it affects us all where it ends up. It is obvious that everything is interrelated. Every decision made has an impact on the bigger picture. Monetary policy can have a positive as well as a negative effect on everyday people. This can be manifested primarily through a shift in employment status. The government, however, has many tools in order to help the situation. These tools at time can improve or even deteriorate the dilemma. They are made to bring the economy out of crisis. But there is no doubt that monetary policy has a tremendous effect on macroeconomic factors as GDF, unemployment, inflation, and interest rates. ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our AS and A Level Macroeconomics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related AS and A Level Macroeconomics essays

  1. Comparing the effects of immigration on GDP in Malaysia, Japan and South Africa.

    8.2.2 Disadvantages on Economic of Malaysia Too much immigrants has also caused some problem. For instances, chances for local workers to be hired are now getting smaller and caused the unemployment rate to increase. 8.3 Politic The political disadvantages of having immigrants in the country is that there will be

  2. Budget 2004-05 and Economic Analysis of Pakistan

    External Receipts 159129 144820 156355 V. Self Financing of PSDP by Provinces 29990 34845 33110 VI. Change in Provincial Cash Balance 27967 14331 31551 VII. Privatization Proceeds 10000 11000 15000 VIII. Bank Borrowing 27936 74036 45150 Total Resources (I to VII) 805234 868392 902770 BUDGET AT A GLANCE - EXPENDITURE (Rs.

  1. Macroeconomic Impact on Business Operations

    The reserve amount stays out. This ratio is controlled by the Federal Reserve System. The money that the borrower spends increases the checkable accounts of the sellers of goods that the borrower purchased with the loan proceeds. This process compounds the effect of the original banks loan.

  2. Fiscal and Monetary Policies

    This lack of growth may be attributed to effects from job growth; tax cuts and lower interest rates. The rate of economic growth means the percent change in Real Gross Domestic Product (RGDP). The low GDP can also be attributed to consumption, investment and government expenditures and net exports. 2.

  1. Examine the difficulties which confront policy makers when they attempt to formulate macroeconomic policy.

    Today Fiscal and Monetary policies are rarely carried out in isolation. However, now Macroeconomic polices stresses the need for a balance between Monetary policies and Fiscal policies. Both policies have been clearly defined and the difficulties which inhibit policy formation for policy-makers have been examined for each policy.

  2. Fiscal policy is a macroeconomic policy.

    Solving the Deflationary Gap using SIMPLE multiplier Increase in government expenditure will increase aggregate demand and the equilibrium level of income, output and employment. The increase of government spending will be bigger effect (in money) due to the multiplier effect.

  1. Governments set economic objectives - Discuss the relative importance of each of these objectives ...

    There are four main sources of increased costs: wages and salaries, imported good, profits and taxes. Wages and salaries account for 70% of national income and hence, increases in wages are normally the single most important cause of increases in costs of production.

  2. This paper will begin by detailing the creation of money and then end with ...

    A negative spread between the Discount Rate and the Federal Funds Rate, which occurs when the Discount Rate is lower than the Federal Funds Rate, signals an opportunity for banks and other institutions to borrow money at a lower than normal interest rate.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work