Economics of Trade and Monetary Institutions

Running head: ECONOMICS OF TRADE AND MONETARY INSTITUTIONS
ECONOMICS OF TRADE AND MONETARY INSTITUTIONS
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ECONOMICS OF TRADE AND MONETARY INSTITUTIONS1
Critically evaluate the shift by many central banks- including those of China, the Euro
area, Japan and the USA- towards further monetary policy easing in 2019
A central bank of any economy performs both macroeconomic and microeconomic
functions to influence the growth and various other factors of an economy. The
macroeconomic function concentrates on stabilising the price level by using several
instruments. This stabilising operation is performed by controlling liquidity movements in the
concerned economy. However, the crucial tool of controlling the money supply is the
adjustment of the rate of interest. Therefore, the central bank uses either contractionary or
expansionary monetary policy to control inflation and liquidity. This is the macroeconomic
function of the central bank, which helps in the adjustment of business expansion,
unemployment and GDP growth. Apart from controlling the market movements and
economic variables, the central bank creates microeconomic influences by supervising the
commercial banks of the country. The borrowing and lending process between a central bank
and a commercial bank helps in the circulation of liquidity in the economy. Today, the central
bank faces several challenges and dilemmas in designing an appropriate policy to boost
economic performance. Therefore, this essay aims at highlighting the major issues that
central banks are facing in the current generation and the real-life contrasts with the economic
theories.
Central banks in the advanced economies face challenges from reducing the long-term
rate of interest, wealth effects, credit movements and foreign exchange rates. Downward
pressure on interest rate is implemented by lowering premiums or by raising inflation
expectations. In the euro area and the UK, there is a prevalence of negative interest rates or
lower bound of interest rates to boost business confidence (imf.org 2019). However, the
credit growth is witnessing a negative trend, which has been targeted by the European banks
and the central bank of England. In contrast to this, the mortgages are recording good growth

ECONOMICS OF TRADE AND MONETARY INSTITUTIONS2
in Japan, the EU and the UK. This has been reflected in the increase in housing prices,
despite the low rates of interest. This scenario is prevalent in the Eurozone and the United
Kingdom.
Apart from this, several economies are facing issues from declining inflation. Falling
inflation implies negative growth in output and a fall in wage rates. These anticipations help
in designing monetary policies (Pfajfar and Žakelj 2018). More specifically, the advanced
economies are facing such challenges as the economy of the United States. Since the
outbreak of the Great Recession of 2007-2008, the United States has been facing several
shocks in its various macroeconomic variables. The Federal Reserve Bank of the United
States has implemented policies such as quantitative easing to reduce interest rates. This is
another form of easing monetary policy. This policy was introduced because of the
ineffectiveness of the monetary policy. Currently, the economy has a stable interest rate at
1.75 to boost business growth and expansion. Moreover, the US was not the only country
facing issues with the recession; the EU and the UK were witnessing shocks as well. Since
then, the European Central Bank (ECB) and the Bank of England follow easing monetary
policy to support business development in the region (Yellen 2017).
Other than the advancing economies, the central bank of the emerging nations is also
facing challenges from several factors. In the current era, the developing nations are
transitioning from a supervised economy into a free-market economy. This limits the
effectiveness of the monetary policies of the central bank. However, the concern still lies in
stabilising inflation. Fiscal policies are ineffective in such a scenario. Thus, the central bank
has to intervene with monetary policy. Emerging economies crave for high growth rates and
good return. Since the fall of the global recession, certain emerging nations are witnessing
large inflows of capital (Ha and Kang 2015). This is because of their short-term lower interest
rate policy. The economies accepting easing policy are experiencing inflows of FDI

ECONOMICS OF TRADE AND MONETARY INSTITUTIONS3
(Boj.or.jp. 2014). This has been witnessed by economies such as Indonesia, Thailand and
India. Despite these positive inward inflows of capital, the volatile and political instability
challenges the central bank from maintaining such an expansionary phase of growth. This
creates a policy dilemma and affects the financial institutions of the country. Apart from this,
emerging or developing nations faces substantial shocks from the fluctuation in exchange
rates (Bhandari and Frankel 2017). The linkages of the domestic business with global bonds
disrupt their growth process. This is because they are exposed to the risks associated with
currency.
Monetary policy is effective depending on the situation of the economy. Monetary
policy is known to increasing consumer demand, investments in business and control
inflation and interest rates. However, this is not always true. This is because it is ineffective
during the recessionary phase, as the Fed was unable to control the global recession in the US
by using monetary policy. The outcomes of the monetary policy implementations require a
long gestation period. Moreover, it is liable to reduce business growth by increasing interest
rates. In such an environment, a business does not find it profitable to operate and prices tend
to rise. Thus, it can limit the growth of the economy. Similarly, China uses an easing policy
to attract investments in the country. The Peoples Bank in China uses easing monetary policy
to enhance economic growth and business improvement. This implies the importance of
reduced interest rates in the Chinese economy.
The concept of macroeconomics implies that there is an opposite linkage between
unemployment and inflation, that is, with a fall in unemployment, there should be an increase
in inflation. Because of this increase in employment, there is an increase in the wages of
labour. This relation is known as the famous Phillips curve. However, the practical life
experiences and records contradict with the Phillips theory. For instance, the 2013 statistics
of the Bank of England suggests that without a tightening monetary policy, the