Monetary policy of the state

Introduction

In this annual paper we will analyze and try to explain what monetary policy is, how does it work and how does it influence the economic stability of the states. In the first chapter I will try to be concerned with all features of the monetary policy which will help us understand the essential things of this policy. First of all we will see what is it about and what the major objectives of the monetary policy are. Also we will discuss about the institutions which take part in this complex monetary system. The most important of these institutions is the nation’s central bank. In this monetary system we also have some other important participants, like commercial banks and the public. Central bank is a public, legal institution which manages and supervises the money supply in the country, so it can control and take care also about the economic stability of the country. Also we will analyze the central bank’s balance sheet and we will see that it differs from a simple commercial bank’s balance sheet.

Then we will speak about the tools of monetary policy. These tools mean the monetary instruments with the help of which the central bank can control, increase and shrink the supply of money in the country. Those three most important instruments we will analyze separately and find out that not all of them have a great impact on the money supply. But anyway, all of them have even a small role in the whole cycle.

Another important thing to be discussed is the types of monetary policy. Because of different usages of the monetary instruments, we can have different final results at the end. So, before applying one or another monetary policy, the policymakers have to know very well the current problems which have to be solved, so the type of the chosen monetary policy will be adequate to the current problems. So, depending on the country’s major economic problems, the monetary policy applied will differ. For example a country with great problems with the inflation will have to implement an inflation-reducing policy, so they can quickly react and lower the inflation. If other than needed is used, the current problems can intensify and also cause some new big troubles for the country and its public.

In the second chapter we will be concerned with the monetary policy of the Republic of Moldova. First of all, there are some general things about the National Bank of Moldova and about the financial and monetary system. Speaking about the monetary policy applied in Republic of Moldova, we will base on the annual report of the National Bank of Moldova for 2006 in which it is analyzed and described the economic situation of the country, monetary policy applied for the last year, achievements for the last year and the objectives which National Bank of Moldova will try to achieve. It will be interesting to find out that the National Bank’s policy now is to lower the inflation which had a relative low level, situated at the level of 10 percent. In the future National Bank intends to reduce it till the level of 5 percent. We have to believe that it is a real objective, if we consider previous years. So, we know that at the begging of our independence we had a very big inflation, which was reduced till now to 10 percent as I mentioned before.

The last thing what I forgot to mention, is that the monetary policy it’s not so easy it sounds, and there are some threats from some economists that believe the results not every time can be obtained as it was intended. It may happen because that, no one can tell you exactly how the commercial banks and the public will react to some new changes in the monetary policy. So the wanted result may not be achieved and the worst is that, the result could be a totally inverse one, so it may result in more problems for the country. But anyway, the studies and experience of the Central banks showed us that the system works and doesn’t have some serious problems.

Chapter I – Monetary Policy

Monetary policy and its goals

Monetary policy can be defined broadly as any policy relating to the supply of money. Since the main agency concerned with the supply of money is the nation’s central bank, the monetary policy can also be defined in terms of the directives, policies, statements, and actions of the nation’s central bank, particularly those from its Board of Governors that have an effect on aggregate demand or national spending. The nation’s financial press and markets pay particular attention to the pronouncements of the chairman of the Board of Governors, the nation’s central banker. The reason for this attention is that monetary policy can have important effects on aggregate demand and through it on real Gross Domestic Product (GDP), unemployment, real foreign exchange rates, real interest rates, the composition of output, etc. However, the fundamental objective of monetary policy is to assist the economy in achieving a full-employment, noninflationary level of total output. Monetary policy consists of altering the economy’s money supply to stabilize aggregate output, employment, and the price level. It entails increasing the money supply during a recession to stimulate spending and restricting it during inflation to constrain spending.

It is paradoxical, however, that these important effects, to the extent that they occur, are essentially only short run in nature. Over the longer run, the major effect of monetary policy is on the rate of inflation. Thus, while a more rapid rate of money growth may for a time stimulate the economy, leading to a more rapid rate of real GDP growth and a lower unemployment rate, over the longer run, these changes are undone and the economy is left with a higher rate of inflation. In some societies where high rates of inflation are endemic, more rapid rates of money growth fail to exercise any stimulating effect and are almost immediately translated into higher rates of inflation.