Money, Banking, Central Banking, and Monetary Policy

Monetary policy refers to the government’s economic strategies which are used for determining the expansion or contraction of money supply in the country. Thus its major function is controlling the aggregated demand and inflation extension in the economy. Moreover, there are three main tools taken by the Federal Reserve to influence or control its monetary policy. The first one is the open-market operations in which the there is the selling of the government securities in the financial market. This securities in return influences the degree of reserves in the banking system. It thus impacts the price and volume of credit or interest rates.

The second one is the discount rate which is basically the rate of interest that the bank pays on short term loans from their respective Federal Reserve banks. Its essence is that is gives the rest of the market the Fed’s monetary plans and changes. The last one is the reserve requirement which is basically the amount of physical funds which the banks are required to hold in their reserve against the deposits in their accounts. This assist in ensuring that they maintain a minimum amount of the physical finances in their accounts reserves (Peter, 2014).

Key factors that influence the quantity of money that people desire to hold

1. a) Interest rates _ Bonds and money are regarded as the store of wealth since they are substitutes. They only differ in two ways i.e. usually money pays less interest although it can be used for purchasing goods and services. On the other hand, although bonds also pays interest they can only used for making purchases once converted into money. This then implies that in case bonds pays the same interest as money, nobody will be willing to use them in making purchases since they are perceived as being less convenient as compared to money. So the higher the bond’s interest rates the less the demand for money and vice versa.
2. b) Consumer spending_ In most case, during the time of higher consumer spending like Christmas, people do end up cashing in other forms of wealth for instance bonds and stocks for the exchange for money. The reason for that is that they will be demanding money for making purchasers. Thus, the increase in consumer spending will result to the rise in demand for money and vice versa.
3. C) Precautionary motive_ in case people feel that they will require money in the near future for making purchases; they will be forced to sell their bonds and hold onto money hence increasing the demand for money (Peter, 2014). For instance, in case people will think that there might be an opportunity of purchasing an asset at low cost in the near future, they will prefer to hold onto money.
4. d) Transaction cost for bonds and stock _ At times, in case people will feel that they might experience some difficulties in buying and selling their bonds and stocks quickly, it means that both of them will be desirable. Thus, they will be forced to hold onto money as the ultimate store of their wealth hence making the demand for money to rise and vice versa.
5. e) Change in the general level of prices _ if inflation strikes a country, it means that goods and services will be more expensive hence making the demand for money to rise. Equally, what it implies is that the level of money holding will also increase the same rate at which the prices for goods and services will be increasing.

The equation of exchange

This usually consists of, M, which is to be multiplied by the V. The velocity of money is Therefore,      M x V = P x Q = Total spending or the GDP (Gross Domestic Product)

Where, M = is the money stock

               V = velocity of money (or basically the number of times funds will be turning over during the        year

             P = price level

             Q = the quantity of goods and services produced       (Peter, 2014)

 

Reference

Peter D, (2014). Macroeconomics: A Fresh Start. Springer Press