University of Pécs, Faculty of Business and Economics
International Ph.D. Program in Business Administration
Essay in Corporate Finance II

Objectives of Monetary Policy

by

Christian Nicke

Table of Contents

I. POLICIES THAT INFLUENCE ECONOMIC DEVELOPMENT AND WELFARE... 3

1. Fiscal Policy... 3
2. Monetary Policy... 4

II. MONETARY POLICY... 5

1. Objectives... 5

a The “magic triangle”... 5
b Full employment... 5
c Equity... 6
d Growth... 7
e Balance of exchange rates... 8
f Price stability... 10

2. Tools... 12

III. LIMITATION OF MONETARY POLICY... 16

IV. BIBLIOGRAPHY... 17

V. APPENDIX:... 20

Welfare and welfare change... 20

I. Policies that Influence Economic Development and Welfare

1. Fiscal Policy

Two fields of policy have a strong impact on a national economy and its development. The first of the two policies that are designed to supplement each other, falls into governments responsibility, more exactly it is formulated by the minister of finance. This one is fiscal policy. The second one, monetary policy, is designed by the national bank. For making clear the difference between both I would like to explain both policies as an introduction to the topic of this paper.

→ Fiscal Policy

“The government’s choice of tax and spending programs, which influences the amount and maturity of government debt as well as the level, composition, and distribution of national output and income. Many summary indicators of fiscal policy exist. Some, such as the budget surplus or deficit, are narrowly budgetary. Others attempt to reflect aspects of how fiscal policy affects the economy. For example, a decrease in the standarized-budget surplus (or increase in the standarized-budget deficit) measures the short-term stimulus of demand that results from higher spending or lower taxes. The fiscal gap measures whether current fiscal policy implies a budget that is close enough to balance to be sustainable over the long term. The fiscal gap represents the amount by which taxes would have to be raised, or spending cut, to keep the ratio of debt to GDP from rising forever. Other important measures of fiscal policy include the ratios of total taxes and total spending to GDP.”¹ In the way of deciding about the amount of expenditures and premises for spending, fiscal policy is an important tool for government for setting macroeconomic conditions.²

2. Monetary Policy

Beside government’s fiscal policy macroeconomic conditions and development also is influenced by the monetary policy of the national bank

→ Monetary Policy

“The process of managing the supply of money and credit to contribute to economic performance. The national bank (original: Bank of Canada) manages the national (original: Canadian) monetary policy mainly through its influence on short-term interest rates, though it is ultimately answerable to the federal government for its actions. The Bank influences short-term interest rates by adjusting its own bank rate. A rise in the bank rate is an act of “tightening” the supply of money and credit, at once restraining elements in the economy which contribute to inflation and elements which contribute to economic performance. The reserve is also true. The bank rate and the money supply influences interest rates and the exchange rate of the national currency (original: Canadian dollar) and determine the monetary conditions in which the (…) economy operates.”³ This definition shows the strong relation between monetary policy and economic development. The objectives of monetary policy and the tools that provide possibilities to achieve these goals are topic of this essay.

II. Monetary Policy

1. Objectives

a The “magic triangle”

[...]

1 www.teachmefinance.com/Financial_Terms/fiscal_policy.html

2 Compare www.answers.com/topic/fiscal-policy

3 www.fin.gc.ca/gloss/gloss-m_e.html