Thinking Positively About Monetary Policy – How “Quantitative Easing” Can Serve The Public Good

Nervous pundits are predicting the end of American life as we know it, after Fed Chairman Ben Bernanke announced on March 18 that he would be dropping yet another trillion dollars in helicopter money – up to $300 billion to buy long-term government bonds and an additional $750 billion to buy private debt, with the Term Asset-backed Securities Loan Facility (TALF) to be opened up for the sake of consumers and small businesses. The dollar immediately experienced its worst drop in 25 years, amid worries that the Fed’s intervention would spur hyperinflation. Typical of the concerned commentators expressing these sentiments was Mark Larson, who wrote in “Money and Markets” on March 20:

“This is Banana Republic-type stuff! And I’m not talking about the clothing store. Printing money out of thin air at the central bank, only to turn around and buy debt securities issued by your Treasury, is the kind of practice you typically see in emerging market regimes. We’re essentially monetizing our country’s debt and deliberately devaluing our country’s currency.”

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Conduct of Monetary Policy

Two views seem to have clearly emerged about the conduct of monetary policy in the country. There are several analysts who think that there is now enough evidence to suggest that the monetary policy stance of the State Bank needs to be eased.

With import growth contained and a steady downward trend achieved in (non-food, non-energy) core inflation, the SBP is in a position to reverse its tight policy and ease interest rates as early as the first quarter of 2007.

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UK Monetary Policy: Does it Work

The main instrument of UK monetary policy is the use of interest rates, set by the MPC. The theory is that interest rates are very effective in controlling inflationary pressures. The relative success of meeting the government’s inflation target in the past 7 years suggests that this proves the effectiveness of monetary policy.

In brief raising interest rates helps to reduce Aggregate demand in the economy. When interest rates are raised several things are affected. Firstly those with mortgages have higher monthly payments, this reduces their disposable income and reduces their spending. Secondly there is an increased incentive to save money rather than spend. Thirdly those who have other forms of borrowing will be hit with increased interest repayments, it will also discourage people from buying on credit. Therefore in principal raising interest rates will reduce demand and prevent the economy from overheating. This enables inflationary pressures to be subdued.

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