Monetary and Fiscal policies are the two economic policies employed by the government in an economy to control the aggregate demand. Using the fiscal policy, the government controls their own expenditure and revenue collection in order to control the economy. Using the monetary policy, the central bank of the country influences the money supply and […]
Monetary and Fiscal Policy
What is Money?
Money as we know it has been around for a very long time. The currency notes and coins that we carry with us everyday are all forms of money. In most simple terms, money can be defined as the medium of exchange. Anything that can serve as a medium of exchange can be called money. […]
How is Money Created?
The process of money creation and the evolution of our current banking system are best explained using stories. One such popular story is the story of a goldsmith. Let’s assume a goldsmith by the name Mark, operating from a small city. Mark is the only goldsmith in his city, and has a strong vault where […]
Official Measures of Money: M1 and M2
There are two official measures of money known as M1 and M2. According to New York Fed: “The money supply measures reflect the different degrees of liquidity—or spendability—that different types of money have. The narrowest measure, M1, is restricted to the most liquid forms of money; it consists of currency in the hands of the […]
Demand and Supply of Money
Demand of Money The demand for money refers to the total amount of wealth held by the household and companies. The demand for money is affected by several factors such as income levels, interest rates, price levels (inflation), and uncertainty. The impact of these factors on the demand for money is explained in terms of […]
Fisher Effect
Fisher effect is an important exchange rate model developed by Irving Fisher in 1930. The Fisher effect provides the relationship between the nominal interest rates, inflation and real interest rates. According to Fisher effect, the nominal interest rate is the sum of real interest rate and expected inflation. It can be expressed as below: Where, […]
What do Central Banks do?
A central bank, also called a reserve bank, is an institution responsible for managing the currency, money supply and interest rates in a country. Central banks also supervise the banking system within a country. Some examples of central banks are Federal Reserve Board in the US, European Central Bank (ECB), People’s Bank of China, and […]
Tools for Implementing Monetary Policy
The central bank of a country employs several tools to implement the country’s chosen monetary policy. This article discusses the three primary policy tools used by central banks. Open Market Operations Under its open market operations, the central bank engages in buying and selling government securities to increase or decrease the monetary base. Open Market […]
Features of Effective Central Banks
The central bank of a country has the core function of managing the monetary policy of the country. They have the challenge of controlling inflation and maintaining price stability. In order to be effective in their core functions, central banks need to have three essential qualities: Independence In order to be effective, a central bank […]
The Monetary Policy Transmission Mechanism
Since the central banks can directly influence the short-term rates (discount rates), it affects the economic growth and inflation through transmission mechanism. The transmission mechanism is illustrated below: The process begins with the transmission of open market operations to market interest rates, either through the reserves market or through the supply and demand for […]