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What Are the Effects of Monetary Policy?

The Federal Reserve often sets monetary policy to control inflation.
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  • Written By: Esther Ejim
  • Edited By: Kaci Lane Hindman
  • Last Modified Date: 05 December 2014
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The effects of monetary policy can be measured by the impact that such policies have on the economy. This impact may be judged by analyzing the effect of monetary policy on macroeconomic factors like demand, interest rates and inflation. Monetary policies usually originate from the chief monetary authority in a country, which is usually the central or reserve bank in the region under consideration.

In most countries, the financial framework is structured in such a manner that there is one main issuer of currency to which the banks in the country are tied. The relationship between this central bank and the other banks is such that the banks are the first tier level of contact with the apex bank. When the apex bank wishes to introduce any kind of monetary policy, these banks serve as a pipeline through which the policy is transmitted into the economy at large. For instance, if the aim of the central bank is to reduce the rate of consumption so as to decrease inflation, it will increase the interest rates. In the effects of monetary policy, this increase in interest rates will be channeled to consumers in the form of increased interests on loans and an increase in the interest paid on savings.

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Concerning the above example, the effects of monetary policy on consumers is to bring about a fall in the level of demand for consumables and other goods and services. When people cannot obtain loans easily or when the interest rate for using credit rises, there is an accompanying decline in the level of demand. At this point, people may decide to save more in order to conserve money, avoid paying high interest rates, and take advantage of the hike in the interest paid on savings. This is an example of the effects of monetary policy on the spending habit or the level of demand by consumers.

An indication of a spiraling increase in the price of goods and services include factors like a shortfall in supply as a result of a mismatch, or disparity between the rate of supply and the demand for goods and services. Such an inflationary trend is usually unwelcome in an economy, because it is usually a precursor to a recession. One of the methods utilized by the central bank to curb the trend is to introduce monetary policies aimed at reducing the indication of inflation in the economy. The effects of monetary policies can be seen in the manner in which such policies often help in the reduction of rising inflation.

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