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Monetary Economy - Monetary Policies and How Banks Try to Achieve Them

Autor:   •  October 23, 2016  •  Coursework  •  834 Words (4 Pages)  •  425 Views

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Monetary Economy

Monetary Policies and How Banks Try to Achieve Them

Price stability

Price stability occurs when the average prices are constant over a long period of time. It can also be experienced when the prices are rising at a predictable rate. However, when there is price inflation, the average prices rises above the low and an unpredictable rate and deflation occurs when these prices fall (Mishkin 24). In either case, the country economic situation or the welfare of the people is extremely negatively affected. In this case, stability of prices is the most important part of an economy. Hence, banks often try their best to ensure that stability is retained.

Central bank controls the level of prices in the economy indirectly by altering the interest rate. Increasing the interest rate when prices are high (inflation) and lowering when prices are low (deflation). During inflation, interest rates are increased by the bank. High interest rates ensures that there is reduced borrowing of money by the economic urgent, who naturally shun from borrowing due to high interest rates (Mishkin 34). This reduces the level of money circulating in the economy and thereby helping reduce the price of goods and service to a desired level (Mishkin 32). On the other hand, during deflation, interest rates on money borrowed from banks is reduced to encourage borrowing. This helps increase prices to a desired level by increasing money circulation in the economy.

High Employment and Output Stability

High employment is a situation when most of the able and willing people in a given country are under active employment. High employment is good because it helps increase independence and self-satisfaction. Output stability refers to a situation when the economy is producing at a constant rate for a long time. High employment and output stability is facilitated by the central bank through ensuring that price stability is being experienced in the economy (Mishkin 43). Under low employment and output levels, the central bank will lower interest rates or conduct an open market operation where private sectors are allowed to access money for investment that creates employment and increase output to desired level. Under excess employment levels or overproduction (which rarely occurs), the reverse would happen.

Economic Growth

Economic growth is an increase in the real gross domestic growth. It is normally calculated in the inflation-adjusted terms to avoid the effect of inflation on the rate of growth. Central bank of an economy plays an important role in influencing economic growth of a country. When the rate of economic growth is low, the central bank will lower interest rates to encourage borrowing and investment by private firms. In this way, private individual and firms have access to funds where they invest, thereby increasing production. In the long run, combined with stability in prices, output and high employment levels, economic growth is realized.

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