What Is the Role of Monetary Policy?

The effect of monetary policy refers to the effect of changes in the money supply on aggregate demand and thus on national income and employment.

Effect of monetary policy

The effect of monetary policy can be measured from two aspects. One is from the quantitative aspect, it is used to measure the size of the role of monetary policy, that is, the quantitative effect of monetary policy; the second is from the time, it is used to analyze the speed of monetary policy, the time effect of monetary policy. That is to say, to measure the effectiveness of monetary policy is to analyze and measure the effectiveness of the effectiveness of monetary policy in solving socio-economic problems, and how long will it take to manifest itself after the policy is implemented.

The measurement of the quantitative effect of monetary policy is a very important aspect, it is related to the monetary policy

There are many factors that interfere with the effects of monetary policy, the most important of which are lagging, reasonable expectations, and politics.

Delay factor

The so-called time lag refers to the time required to objectively formulate a policy according to the actual economic situation until the expected impact of this policy on economic activities is fully displayed. It is composed of internal and external time lags.

Internal time lag refers to the process from when the economic and financial situation changes require the central bank to take policy action to when the central bank actually takes action. It can be divided into two parts: Recognition time lag refers to the time required from the emergence of a situation requiring monetary policy action to the moment when the monetary authorities realize that action must be taken. Its length is related to the understanding of the situation by the monetary authorities and the forecast of the economic situation. Administrative time lag refers to the time required for the monetary authorities to recognize and take policy action and then actually take action. Its length is related to the decision-making system and determination of the monetary authorities.

External time lag refers to the period from the date when the central bank takes monetary policy actions to the time when it has a sufficient impact on economic activities. It can also be divided into two parts: steering delay. After the monetary authorities take policy actions, they use the intermediary indicators to adjust the level of money supply or interest rates. In the face of the new economic and financial situation, various economic units will inevitably change their decision-making and spending behavior. A period of time is the steering lag. Production delay. After each economic unit changes its economic behavior, it will affect the production, employment and income of the whole society. These effects are mainly determined by the production process, so it is called production lag. External time lag is mainly determined by objective economic and financial conditions and is less controlled by monetary authorities. Since the 1960s, Western economists have adopted various econometric models in an attempt to estimate external delays. Their estimates have never been consistent, but most studies have shown that it takes at least six months, or even two years, for monetary policy to achieve its ultimate results.

2. Rational Expectation Factors

Rational expectation refers to the expectation made by people who have fully grasped all available information. The reason why this kind of expectation is called reasonable is that it is a kind of expectation made by people after careful consideration with reference to the relevant knowledge provided in history. The theory of rational expectations is different from Keynes and Friedman's theory of expectations. Keynes's theory of expectation is blind expectation, which is based on the premise of people's psychological irrationality and has become a factor of economic instability and even periodic fluctuations. Friedman's expectations are adaptive expectations, which means that people passively adjust their expectations in order to adapt to changes in the objective economic situation. When people make adaptive expectations, they do not have sufficient information, mainly based on their own experience. Or remember to predict the future and be prepared to revise your forecasts at any time. When people make reasonable expectations, they have sufficient information in advance, and after careful thinking and judgment, they take the initiative to make wise treatment, so they have rational expectations.

3. Political factors

Political factors have a great impact on the effects of monetary policy. It may cause the central bank to deviate from the correct policy and even partially invalidate monetary policy. Any monetary policy brings different benefits to different classes, groups, departments or localities. In order to maximize their respective gains or losses, these entities often form certain political pressures, forcing monetary policy to adjust in their favor.

For its own benefit, the bureaucracy may disregard the interests of the public and the public, resulting in a political economic cycle that affects the effectiveness of monetary policy. In many western countries, the political process is short-term, and the government must change its term every few years. Because low unemployment and high production will bring a lot of votes to the ruling party, the government tried to stimulate the economy before the general election, and tended to adopt an expansionary monetary policy to reduce the unemployment rate and increase output. However, the implementation of monetary policy should be long-term and must be continuous, and the pressure of frequent government turnover may lead to short-term monetary policy. In addition, some special interest groups may consider their own interests and exert pressure on the decision and implementation of monetary policy. For example, bankers always want interest rates to remain high in order to benefit from them, which may force central banks to implement austerity monetary policies. The housing construction industry, which has been greatly affected by rising interest rates, may unite, forcing the central bank to implement an excessively expansionary monetary policy to delay the rise in nominal interest rates.