Effects of Monetary Policy on the Economy

Monetary policies are formulated by a country’s central bank in order to regulate the flow of money and the performance of the economy. A strict monetary policy makes it hard for the public to access finances hence creating an inflated economy. In such situations, people have difficulties accessing money hence lowering the purchase power. Households and firms become the recipients of the impacts of monetary policy, which affects them either in positive or negative ways. Monetary policy has a vital influence on inflation by inducing changes on the borrowing rates. Monetary policies have a direct influence on borrowing rates making it cheap to borrow finances. The easy access to finances because of low borrowing rates increases the purchasing power by the public. This lowers the levels of inflation as people are able to access basic needs and services. In response to the high demand and spending by the households, firms will hire more workers to increase production. This results in high employment thereby lowering inflation rates. Monetary policy therefore, has a positive effect on the economy by lowering inflation through low borrowing rates. Another effect of monetary policy is the increase in spending by the government because of tax cuts. This results in the increase in the Gross Domestic Product and an overall effect on imports and exports of a country. The demand for imports will increase with an increase in the Gross Domestic Product hence encouraging foreign purchasing. Banks will therefore, have to convert domestic currency into foreign currencies to facilitate importation of goods and services. Because of this, foreigners will partially hold domestic currency and have an influence on transactions of a nation’s financial assets. In conclusion, monetary policy has affects both positive and negative effects on the behavior of an economy. In times of inflation, governments come up with monetary policies to lower the intensity of inflation. Monetary policy may be used to lower the borrowing rates hence encouraging financial borrowing and spending.