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.
“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.” 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.
At a glance
- Examines the ECB’s price-stability objective and its Maastricht Treaty basis
- 26 sources in the bibliography
- 3 figures
Table of Contents
I. POLICIES THAT INFLUENCE ECONOMIC DEVELOPMENT AND WELFARE
1. Fiscal Policy
2. Monetary Policy
II. MONETARY POLICY
1. Objectives
a The “magic triangle”
b Full employment
c Equity
d Growth
e Balance of exchange rates
f Price stability
2. Tools
III. LIMITATION OF MONETARY POLICY
Objectives and Themes
This essay introduces the objectives of monetary policy and the instruments central banks use to pursue them. It considers how monetary policy relates to economic development and welfare, how its various goals interact, and what limits its contribution to economic prosperity.
- Fiscal and monetary policy and their respective roles
- Employment, equity and economic growth
- Exchange rates and price stability
- Central bank instruments, including open market operations and interest rates
- The European Central Bank’s mandate and the limitations of monetary policy
Excerpt from the Book
Price stability
As the objective of price stability is strongly related with the other aims of monetary policy because of its impact on economical development and therefore on labour market and the overall prosperity of a nation, the target of price stability is (especially in the European Community for the ECB) the focus of activities. This objective was already defined in the Maastricht Treaty, were the following passage is enclosed:
“ARTICLE 105
1. The primary objective of the ECB shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community (…). The ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources (…).”
Price stability constitutes a pivotal framework condition for the national economic activity. A stable price level ensures that consumers and investors in business could decide about consumption and investments under stable and predictable conditions and thus has a positive impact on economic activity and employment. But, to obtain this aim a clear definition of price stability is needed. “To specify the price stability objective, the Governing Council of the ECB announced the following quantitative definition in 1998: ‘Price stability shall be defined as a year-on-year increase in the HICP (harmonised Index of Consumer Prices, the author) for the euro area of below but close to 2%. Price stability is to be maintained over the medium term.’
The Governing Council publicity announced its quantitative definition of price stability for several reasons. First, by clarifying how the Governing Council interprets the goal it has been assigned by the Treaty, the definition helps to make the monetary policy framework easier to understand (i.e. it makes monetary policy more transparent). Second, the definition of price stability provides a clear and measurable yardstick against which the public can hold the ECB accountable. Deviations of price developments from the definition of price stability can be identified, and the Eurosystem would then be required to provide an explanation for such deviations and to explain how it intends to re-establish price stability within an acceptable period of time. Finally, the definition provides guidance to the public for forming expectations of future price developments. The definition of price stability makes clear that the Eurosystem has a euro area-wide mandate.”
Chapter Summaries
POLICIES THAT INFLUENCE ECONOMIC DEVELOPMENT AND WELFARE: The opening chapter distinguishes fiscal policy, directed by government, from central bank monetary policy. It introduces their roles in shaping economic conditions.
MONETARY POLICY: This chapter discusses the objectives of monetary policy, from employment and equity to exchange rates and price stability. It also introduces instruments used by central banks, including open market operations and interest rates.
LIMITATION OF MONETARY POLICY: The final chapter considers the limits of monetary policy’s influence on economic performance and discusses criticism of prioritising price stability.
Keywords
monetary policy, fiscal policy, central banks, price stability, full employment, social equity, economic growth, exchange rates, inflation, open market operations, interest rates, European Central Bank, monetary policy instruments
Frequently Asked Questions
What is this essay about?
It examines monetary policy objectives, the instruments used to pursue them and their relationship to economic development and welfare.
What are the central themes?
The essay addresses employment, equity, growth, exchange rates and price stability, alongside fiscal policy and central bank tools.
What is the main aim of the work?
Its aim is to introduce the goals of monetary policy and explain the tools available to central banks to pursue them.
What method does the author use?
The author develops a descriptive discussion using books, institutional publications, policy documents and other cited sources.
What does the main body cover?
It discusses individual monetary policy objectives and explains instruments such as changes to the monetary base, open market operations, interest rates and exchange-rate measures.
Which keywords characterise the essay?
Key terms include monetary policy, price stability, full employment, economic growth, exchange rates and central bank instruments.
What is the “magic triangle”?
The essay presents it as a model linking full employment, price stability and foreign trade balance as important monetary policy goals.
How does the essay use the European Central Bank as an example?
It discusses the ECB’s price-stability mandate, the Maastricht Treaty and the relationship between price stability and other economic objectives.
What role do exchange rates play in the discussion?
Exchange rates are considered both as a policy objective and as a channel connected to trade, inflation, economic activity and financial flows.
- Quote paper
- Dipl.-Betriebswirt (FH) Christian Nicke (Author), 2007, Objectives of Monetary Policy, Munich, GRIN Verlag, https://www.grin.com/document/80392
