Central Bank and Monetary Policy Research Paper

Central Bank and Monetary Policy - Research Paper Example This paper deals with central bank objectives, instruments and theory behind them. Five objectives of central banks will be described and discussed. Central banks’ objectives are price stability, stable real growth, financial stability, and interest rate and exchange stability. Then, direct and indirect tools of monetary policy will be described and discussed. Direct tools affect directly the economic agents (Alexander et al., 1996, p.14). Indirect tools affect bank reserves (Alexander et al., 1996, p.14). Direct instruments are: interest rate controls, credit ceilings, and directed lending to the authorities (Alexander et al., 1996, p.14). Indirect instruments are open market operations, reserve requirements, and central bank lending facilities (Alexander et al., 1996, p.14). Advantages and disadvantages of both will be discussed. It will be described how the central banks control the economy through money supply and how price stability is related to other objectives of centr al banks, but only as long as money supply can be controlled by the central bank. Finally, United Arab Emirates (UAE) will be shortly analyzed and the performance of their central bank will be discussed. It will be shown that the central bank of UAE’s focus is on exchange rate and economic stability. Since the UAE dirham is pegged to the US dollar, inflation cannot be controlled by the central bank of UAE as its monetary policy is restrained by the peg. Instead, it depends on the inflation in the USA, since the USA is free to adjust its monetary policy. ... Today, they service both, the governments and the commercial banks (Cechetti & Schoenholtz, 2011, Chapter 15). By 2011, there were around 170 central banks in the world (Cechetti & Schoenholtz, 2011, Chapter 15). Though central banks around the world nowadays do not all have the same objectives, most share certain characteristics. They are in charge of monetary policy as the government’s bank (Cechetti & Schoenholtz, 2011, Chapter 15). In countries where the central bank is largely independent to determine the interest rate on its own, the goals toward which the monetary policy should be used are independent of political events. Central banks’ goals are following: price stability, stable real growth, financial stability, interest rate and exchange stability. Each will be shortly discussed with regard to its importance for the central bank and the wider economy. Stable real growth is an objective of some central banks. A central bank can through independence from politic al processes and a consistent policy promotes economic stability and decreases uncertainty and fluctuations in economic growth rates (Cechetti & Schoenholtz, 2011, Chapter 15). A central bank may insulate an economy from business cycles through independence by ensuring the long – run growth potential is promoted, so that fluctuations in growth rates do not occur, or are minimized (Cechetti & Schoenholtz, 2011, Chapter 15). The long – run growth potential is determined by factors such as capital stock, the size of the capital stock and labor force size (Cechetti & Schoenholtz, 2011, Chapter 15). However, active monetary policy is no longer favored by most central banks. Since effects of