Discuss what might be the effects of monetary policy on employment and growth.
Monetary policy affects employment and inflation through modifying the availability and cost of
credit in the economy through its policy tools. Three basic monetary policy tools available to central
banks are the reserve requirement ratio, open market operations, and the discount rate. The reserve
requirement ratio is a proportion of initial deposits that must be retained by the central bank. They
can either hold the reserves in their vaults or deposit them with the central bank. Banks can lend
more of their deposits if the reserve requirement is low. Discount rate is when the central bank
charges member banks a discount rate to borrow at its discount window. Banks only use it if they
can't borrow funds from other banks because it's higher than the fed funds rate. Open market
activities are the buying and selling of government bonds and securities to commercial banks and
the public. These are bought from or sold to the private banks in the country. The central bank adds
cash to the banks' reserves when it buys securities. This enables them to extend more credit. When
the central bank sells securities, it adds them to the banks' balance sheets and lowers its cash
reserves.
The central bank employs monetary tools to implement expansionary and contractionary monetary
policies. Contractionary monetary policy slows the economy and slows economic growth, whereas
expansionary monetary policy helps to speed up the economy and increase economic growth. High
unemployment rates during recessions are an example of expansionary monetary policy, while an
overheating economy is an example of contractionary monetary policy. Monetary policy has three
limitations. The first is the time lag, in which monetary policy actions affect output and employment
for 3 months to 2 years, the second is interest rates, in which raising interest rates can have a
negative impact on investment consumption, the exchange rate, and thus the balance of payments,
and the third is the liquidity trap, in which interest rates are close to zero and the central bank is
unable to lower the interest rate through expansionary monetary policy.
In conclusion, monetary policy is effective at bringing the economy back into balance. It encourages
maximum employment, price stability, and economic growth.