explain monetary policy and its effect on business (500 words)
Answers
Answer:
Explanation:
Monetary policy impacts the money supply in an economy, which influences interest rates and the inflation rate. It also impacts business expansion, net exports, employment, the cost of debt and the relative cost of consumption versus saving—all of which directly or indirectly impact aggregate demand.
MONETARY POLICY
Monetary policy is the term used by economists todescribe ways of managing the supply of money in an economy. Monetary policy isthe process by which the monetary authorityof a country controls the supply ofmoney, often targeting a rate ofinterestfor the purpose ofpromoting economicgrowth and stability. The official goals usually includerelatively stable prices and low unemployment. Monetary economics provides in sight into how to craft optimal monetary policy.Monetary policy is referred to as either being expansionary or contractionary, wherean expansionary policy increases the total supply of money in the economy morerapidly than usual, and contractionary policy expands the money supply more than usual or even shrinks it. Expansionary policy is traditionally used to tryto combatunemploymentin arecessionby loweringinterest ratesin the hope thateasy credit will entice businesses into expanding. Contractionary policy is intendedto slow inflationin order to avoid the resulting distortions and deterioration of assetvalues.
Effect on business:-
The effect of an expansionary monetary policy is to lower the exchange rate,weaken the financial account and strengthen the current account. A restrictivemonetary policy would be expected to result in the opposite: a higher exchange rate,a stronger financial account and a weaker current account (a more negative or
positive balance of trade).With a program of expansionary (easy) monetary policy, the following sequence ofevents would be expected to occur with regard to the income effect:
The domestic GDP will rise - The rise in domestic GDP will tend to increase the demand for imports.The increase in imports will cause the current account to deteriorate.· The increase in imports purchased will increase the need to convert domestic toforeign currency. As a result, the exchange rate of the domestic currency will decrease.·With no government intervention, the financial account must now move toward asurplus as the financial and current account must sum to zero. Due to the increase inimports, foreigners will now have a surplus of the nation's currency. If foreigners donot use that currency to purchase the country's exports (which would improve the 07274current account balance), they will ultimately need to invest that currency in theassets of the domestic country. This explains why countries such as Chinaand Japaninvest large sums in assets such as U.S. Treasuries. The holdersof the U.S.currency must put it to work somewhere! Note that foreign investors areoften getting better rates of return than what might be readily apparent because thevalue of the domestic currency is falling relative to their own currency.