What is Monetary Policy?
An economic policy designed to influence the size and growth rate of the money supply in an economy.
Objectives of Monetary Policy
A) Inflation Management
B) Unemployment Management
C) Exchange Rate Maintenance
Tools of Monetary Policy
i) Interest Rate Adjustment
– The central bank (Bank Negara Malaysia) can influence the interest rates of a country at any given time by changing the discount rate.
– The discount Rate (Base Rate) is an interest rate charged by the central bank to commercial banks for short-term loans
– Any increase in the discount rate by central will cause a raise in the cost of borrowing for banks. This will lead to commercial banks increase the interest rates charged to its customers. This is a form of reaction towards the increase in discount rate made by the commercial banks.
ii) Changes in Reserve Requirements
– The central bank is responsible for dictating the minimum required amount of reserves to be held by commercial banks.
– The decisions made regarding the require amount of reserves will directly influence the money supply in the economy
An increase in the required reserve amount, will lead to commercial banks possessing less money available for lending to its clients, thus leading to a reduction in the money supply of the economy.
Expansionary & Contractionary Monetary Policy
The objectives & tools that is utilised for the intention of influencing the economy in a particular way can be categorised into either expansionary or contractionary monetary policy
i) Expansionary Monetary Policy
– The policy was designed to increase the money supply in the economy by means of
i) Decreasing Interest Rates
ii) Purchase of Government Securities
iii) Lowering the required reserve requirements for commercial banks
ii) Contractionary Monetary Policy
– The purpose of a contractionary policy is the opposite of an expansionary policy. The idea of the policy can be summarised as an attempt to control economic growth and influence inflation rates. These factors similar to an expansionary policy are as follows:
i) Increased Interest Rates
ii) Sale of Government Bnds
iii) Increase Reserve Requirements
Case Study Example
We have analysed the recent article released by the World Gold Council regarding the implications of monetary policy on Gold.
Before we dive into the implications of monetary policy, WGC has released some guidelines to understand the drivers of Gold
Drivers of Gold Identified
– It is essential to understand that Gold is a unique form asset by sole means that it appeals different to investors and consumers. Investors are said to utilise Gold as a means to diversify and as a tool for long-term savings management. In the case of consumers, Gold is viewed as adornmnet and a sign of wealth
The World Gold Council believes that the followng factors influence Gold
i) Economic Expansion: Periods of growth are very supportive of Jewellery, Technology and Long-term Savings
ii) Risks & Uncertainty: Market downturns will often raise opportunities to boost investment demand for Gold as a safe haven
iii) Opportunity Cost: The price of competing assets such as bonds & currencies
iv) Momentum: Capital flows, positions & price trends can ignite or dampen Gold’s performance.
The recent meeting held by the Federal Reserves regarding market expectations has seen the latter shifting its position from a tightening stance to a neutral market position. The result of a neutral position has seen Gold Prices increased.
Based on the graph below, it can be identified that the a contractionary monetary policy is being employed as interest rates are increasing, reducing the overall money supply in the economy.
Source: Bloomberg, World Gold Council, 2019
Source: BloomBerg, World Gold Council, 2019
Similarly, We can see identify the impact of interest rates on gold through the graph below. It can be noted from the graph above that there is a growing importance of the US interest rates in the last quarter of 2018 until the current period, affecting Gold performance.
The Information was adapted from both The World Gold Council & Corporate Finance Institute
“>View For More Information From Corporate Finance