Chapter 4: Monetary Policy: Overview of Concepts, Debates and Issues
MONETARY POLICY Monetary policy is a key component of economic policy. It refers to policy actions taken by a central bank to change the monetary and financial conditions in an economy. The aim of monetary policy is to achieve either a single objective, for example, low and steady inflation, or multiple objectives such as low inflation, steady economic growth, equilibrium in the balance of payments, and interest and exchange rate stability. The policy instruments that central banks deploy to bring a required change in the monetary and financial condition in the economy include short-term interest rates, bank credits and bank reserves. These instruments are interrelated; their deployment and effectiveness depend on exchange rate arrangements, monetary policy frameworks, and controls and regulations over capital flows (Cheng, 1988; Mishkin, 2007a; Walsh, 1998). Monetary policy and central banking are intertwined. Monetary policy as a concept, however, is not as old as central banking. As reviewed in Chapter 3, central banks were first established in Europe more than three centuries ago. Monetary policy as a distinct component of economic policy was not identified until around the time of the First World War. Since then the scope of monetary policy has become wider. It encompasses established activities of central banks, including nineteenth-century functions connected with implementing rules and regulations, rather than direct intervention of economic activity. In this historical context, it can be difficult to distinguish monetary policy from economic policy in general. Nevertheless, as a general principle, it is possible to define modern monetary...
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