Question

The heydays of fiscal policy was 1960s. Since then it lost credibility due to concern of persistently large budget deficits and uncertainty over political system whether it can make tax and spending decisions in a timely way to achieve desirable stabilization outcomes. Monetary policy henceforth was the dominant policymaking tool. During the late 1970s, an overly loose monetary policy was commonly thought to have contributed to the burst of double-digit inflation in 1979 and 1980. Tight monetary policy engineered by the Federal Reserve of the US under the leadership of Chairman Paul Volcker brought down inflation, but also dragged the economy into a deep recession. High real interest rate in the mid-1980s are often linked to the large run-up in the exchange rate value of the dollar and the resulting temporary decline in competitiveness of American industry. Lower interest rate then helped extend the economic upswing of the 1980s, and also bring down the dollar exchange rate. But when it seemed that inflation might be accelerating again in the late 1980s, the Fed under Alan Greenspan tightened once more. After the recession of 1990-91, lower interest rates helped the economy recover. Since, early 1994, the Fed has raised interest rates to preempt about of increased inflation arising from an overheated economy. In recent times, the Fed under the Chairmanship of Ben Bernanke lower the interest rate in late 2008, under the quantitative Easing program to rock bottom to thwart the financial crisis that gripped the world economy. An accompanying figure of the yield of 10 years US securities serves to illustrate the timeline of the interest rates described above. Monetary policy is a powerful tool, which work its way through transmission mechanism using distinctive channels. These channels, through which this transmission mechanism works, include interest rate effects, exchange rate effects, other assets price effects and credit channel effects.

Elucidate the transmission mechanism of monetary policy with respect to its distinctive channels as mentioned above.

Answer 1

Answer - The monetary policies help a great deal in controlling the various aspects of the economy. The increase in the interest rates will lead to the expansion of the money supply and the reverse will lead to the contraction. Also the increased money supply , will lead to the lower exchange rates and hence increased exports. The credit making increases. The other monetary policies will include the sale and purchase of the securities in the market thus affecting the exchange rates.