Unit 12 : Monetary Policy

Question 1

What is the definition of reserve requirement/discount rate/open market operations?

Answer 1

Reserve requirement refers to a certain percentage of deposits that the central bank requires all banks to keep in reserve.
Discount rates refer to interest rates that the central bank charges for loans to other banks. Banks have to pay interests in advance.
Open market operations refer to the central bank’s buying or selling G securities (mostly G bonds)

Question 2

How can the Central Bank make changes to each tool of its monetary policy if it wants to run an expansionary monetary policy? Or restrictive monetary policy?

Answer 2

In order to run an expansionary monetary policy, the central bank can buy G securities or reduce reserve requirements or discount rates.
If the central bank want to run an restrictive monetary policy, it can sell G securities or increase reserve requirement, discount rate.

Question 3

What can the central bank do to increase the money supply? Or to reduce the money supply?

Answer 3

The central bank can buy G securities or reduce reserve requirements/ discount rates, the money supply will increase.
By selling G securities or increasing reserve requirement/ discount rates, the money supply will decrease.

Question 4

What is an expansionary monetary policy? When should monetary policy be expansionary? Why?

Answer 4

An expansionary monetary policy means the central bank buy G securities or reduce reserve requirements/ discount rates to promote economic growth and to increase employment for the local people.
The monetary policy should be expansionary when economic growth rate is still low or unemployment rate is still high. By buying G securities, reducing reserve requirements or discount rates, that increases the money supply, lowers interest rates, and increases aggregate demand, leading to more production of goods and services. Thus, the economy tends to grow.

Question 5

What is an restrictive monetary policy? When should monetary policy be restrictive? Why?

Answer 5

An restrictive monetary policy means the central bank sell G securities or increase reserve requirement/ discount rate to decrease inflation rates.
The monetary policy should be restrictive when inflation rate is high. By selling G securities, increasing reserve requirements or discount rates, the money supply will reduce. Firms and individuals will have less money to spend, leading to a decrease in aggregate demand, then prices will reduce and lower inflation.

Question 6

SUMMARY

Answer 6

There are some main ideas in Unit 12: tools of monetary policy, expansionary and restrictive monetary policy.
Firstly, there are 3 main tools of monetary: reserve requirement, discount rate, open market operations
Secondly, an expansionary monetary policy means the central bank buy G securities or reduce reserve requirements/ discount rates when economic growth rate is still low or unemployment rate is still high. By buying G securities, reducing reserve requirements or discount rates, that increases the money supply, lowers interest rates, and increases aggregate demand, leading to more production of goods and services. Thus, the economy tends to grow.
Finally, an restrictive monetary policy means the central bank sell G securities or increase reserve requirement/ discount rate to decrease inflation rates. The monetary policy should be restrictive when inflation rate is high. By selling G securities, increasing reserve requirements or discount rates, the money supply will reduce. Firms and individuals will have less money to spend, leading to a decrease in aggregate demand, then prices will reduce and lower inflation.