Sunday, June 14, 2009

monetary indicators and monetary policy tools

a change in bank Rate by the bank of England, or a change in the discount rate by the federal reserve banks in the 1920 's, was commonly thought to be the major policy tool used by central banks in those countries, and in other countries as well .In this period,three fundamental propositions underlay much of the theory of central banking;(1)a change in the central bank interest rate would assure a generally corresponding change in interest rates at commercial banks;(2)a change in the level of interest rates could be summarized as being a change in "the"interest rate,because it was assumed that there would be a synchronous change on yields on comparable debt instruments of all maturities;and(3)whenever interest rates changed as a result of central bank action,there would be changes in the amount of funds offered by lenders and changes in saving by consumers out of income.
Some 50 years later,in the 1970s,a much greater stress was placed on controlling the growth of the money supply with less emphasis being placed on deliberate variations in central bank lending rates, e.g.,the discount rate. The preferred instrument of monetary policy is now open market operations and direct control over the growth in bank reserves,and the growth in the money supply is implemented through the purchase and sale of government securities.
A change in the discount rate is now looked upon as a "signal"of the intentions of the monetary authorities to carry out a particular monetary policy of credit ease or credit restraint rather than a major tool in and of itself.Furthermore,the use of market interest rates as an indicator of monetary policy is subject to considerable measurement error because of the impact on such interest rates of many influences other than monetary policy, e.g.,a change in the budget deficit or a variation in business loan demand.
Furthermore,there is increasing empirical evidence that changing rates of growth of the money supply do have a significant impact on both the price level and the rate of growth of real output.Hence,more observers put increasing emphasis on judging the intentions of the monetary authorities by weekly,monthly,quarterly,and annual data on the growth of the money supply.Although some variation in the growth of the money supply may be the result of some forces other than those of monetary policy,ultimately the control of the growth of the money supply is in the hands of the monetary authorities.However,insofar as the central bank controls the money supply,it is through its control over bank reserves.
internal links:
1- this link about monetary policy tools
http://thefutureofmoney.blogspot.com/2009/07/monetary-policy-tools.html

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