Easy Monetary Policy - Explained
What is Monetary Easing?
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Table of ContentsWhat is Monetary Easing?How does Monetary Easing Happen?Inflation and Easy MoneyAcademic Research on Easy Monetary Policy
What is Monetary Easing?
Easy money is an economic term used to describe money supply. It is also known as monetary easing and expansionary monetary policy. The Central Bank of every country is tasked to regulate money supply in the country. In the United States, the money supply in regulated by the Federal Reserve Bank. The money supply concerns the amount of currency issued into society. They use different tools to inject or contract the money supply. For example, when the Federal Reserve Bank wants to increase money supply in the country, it lowers the overnight interest rate (the rate charged to banks to borrow money). As such, borrowing for banks becomes less costly. This, in turn, makes money more accessible and less costly for borrowers from the lender banks.
How does Monetary Easing Happen?
As discussed, monetary easing occurs when the Federal Reserve Bank wants to increase the money supply in the country. The purpose of monetary easing is to stimulate economic growth and to push down the unemployment rate in the country. The economic stimulus is caused by the effect of introducing more money into the system. This primarily happens in two manners: Through the Federal Open Market, the Federal Reserve Bank purchases treasury securities from the US Government. Through government spending (spending programs, grants, employee salaries, etc.) the money will be injected into economy and vice versa. The next method is by lowing the overnight interest rate at which banks (lending institutions) borrow money. This gives these borrowing banks more money to lend. If money is easier to acquire by loan, individual consumers are more able to acquire loans to purchase things, such as houses, cars, etc. It also makes it easier to expand businesses operations by purchasing additional equipment, upgrading facilities, and hiring more employees. This increases the supply side of the economic production-consumption equation. Also, the money spent on equipment, facilities, and employees flows into the economy (think about the businesses selling the equipment and the employees with more money to spend) and creates additional demand. The total production and consumption increases.
Inflation and Easy Money
Central banks are reluctant to maintain an easy money policy (low overnight interest rate) for long periods of time, as it may create inflation in the country. Inflation causes the purchasing power of money to diminish (meaning that prices for goods and services rises). As such, the Federal Reserve Bank may adopt monetary policy according to the needs of economy. For instance, if there is inflation and the government wants to control inflation then the Federal Reserve Bank may adopt contractionary monetary policy. If there is need for investment and the unemployment rate is rising, the bank may adopt expansionary monetary policy to foster economic activities in the country.
Academic Research on Easy Monetary Policy
- Ultra easy monetary policy and the law of unintended consequences, White, W. R. (2012).real-world economics review,1(1). This article studies the need for ultra-easy monetary policy. The research is carried out by comparing the positive short-run impact and the negative long-run impact. The negative impacts are unintended consequences of the policy. Some of the consequences include the ability of the ultra-easy policy to threaten the stability and function of financial institutions, to limit the power of central banks, and to promote brash actions by the government.
- Some cross-country evidence about debt, deficits and the behavior of monetary and fiscal authorities, Mlitz, J. (1997). (No. 1653). CEPR Discussion Papers. The behavior and dealings of monetary authorities are analyzed in this article. The results were drawn from data obtained from 15 European Union countries except for Luxembourg and 5 OECD countries. The article also discusses the three basic conclusions deduced from the results, ranging from the stabilizing response of monetary and fiscal policies to the existence of the macroeconomic policy.
- The role of monetary policy, Friedman, M. (1995). InEssential Readings in Economics(pp. 215-231). Palgrave, London. The basic economic policy goals agreed on are fast economic growth, stable market prices and high rate of employment. Not all agree on whether these goals are compatible or the order in which to combine them. There is even less agreement the roles monetary policy plays in the achievement of these economic goals.
- Asymmetric effects of monetary policy, Morgan, D. P. (1993).Economic Review-Federal Reserve Bank of Kansas City,78, 21-21. This paper seeks for evidence of the asymmetric effect of monetary policy using two alternative measures of policy. The measures are the narrative index obtained from statements of policymakers and the federal funds rate. Using both measures of policy the author was able to find evidence of asymmetry. The first part of the article traces the history and causes of asymmetry while the second part shows evidence of the asymmetric effect of monetary policy.
- Inside the black box: the credit channel of monetary policy transmission, Bernanke, B. S., & Gertler, M. (1995). Journal of Economic Perspectives,9(4), 27-48. According to the credit channel theory, tight money periods are characterized by poor information exchange in credit markets. This article discusses how the credit channel theory helps to explain the effect of monetary policies on GDP and its components. The major elements, bank lending, and balance sheet channels of the theory are also discussed.
- Inflation targeting: a new framework formonetary policy?, Bernanke, B. S., & Mishkin, F. S. (1997). Journal of Economic Perspectives,11(2), 97-116. Inflation targeting policy allows the monetary authorities flexibility in its policy rule as opposed to an inflexible one in the Friedman sense. Although inflation targeting has been adopted by quite a lot of developed countries in the past few years, the authors argue that it is best comprehended as a wide structure for policy that gives policymakers freedom to vary policy instruments within well-defined limits. The paper further discussed the potential of inflation- targeting approach in making monetary policy reasonable, unambiguous and more disciplined.
- Inflation forecasts and monetary policy, Bernanke, B. S., & Woodford, M. (1997) (No. w6157). National Bureau of Economic Research. The article addresses the problem of rational expectations equilibrium that arises when private sector predictions are used by the central banks to guide policy actions. It demonstrates that policies made using strict target inflation forecasts have negative consequences. The authors conclude that even though forecasts from the private sector may prove to be useful to the central bank, it is best for monetary authorities to use structural models of their economy to guide policy decisions.
- Monetary policy and exchange rate volatility in a small open economy, Gali, J., & Monacelli, T. (2005).The Review of Economic Studies,72(3), 707-734. This article explores the Calvo model of sticky prices in international trade and demonstrates how equilibrium dynamics can be used to represent local inflation and the output gap. It shows the main difference between the three rule-based policy system of managing small open economy: CPI-inflation-based Taylor rules, domestic inflation, and exchange rate pegs.
- Zero bound on interest rates and optimal monetary policy, Eggertsson, G. B. (2003). Brookings papers on economic activity,2003(1), 139-233. The question of how policies would be managed when the zero bound is reached creates a lot of fundamental problems for the theory of monetary policy. This article seeks to clarify these problems by studying the effect of zero lower bound on nominal interest rates. It also shows how the existence of zero bound alters the character of optimal monetary policy.
- Interpreting the macroeconomic time series facts: The effects of monetary policy, Sims, C. A. (1992). European economic review,36(5), 975-1000. This paper reevaluates the existing evidence and theory on the impacts of monetary policies. It provides new evidence obtained from studies carried out in several countries. It was observed that some countries showed similar patterns in data that can be related to effective monetary policies while other data cant be associated with the effective monetary policy.
- A general equilibrium approach to monetary theory, Tobin, J. (1969).Journal of money, credit, and banking,1(1), 15-29. The article illustrates the general framework of monetary analysis. The article contains models that are meant to shed light on the various approaches to monetary analysis.
- Capital requirements, monetary policy, and aggregate bank lending: theory and empirical evidence, Thakor, A. V. (1996). The Journal of Finance,51(1), 279-324. The model foretells that the decision of the bank to lend will cause a massive rise in the price of borrowers stock. This article provides proof to supports this prediction. The model explained that despite increasing the supply of money, the Federal Reserve was unable to increase bank lending. The article demonstrates that increasing the supply of money will either increase or decrease bank lending when capital requirements are solely associated with credit risks.