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¿What is monetary policy?
Monetary policy is the set of measures taken by the monetary authority whose principle objective is to obtain the stability of the value of the currency and avoid extended imbalances in the balance of payments. It is to be found in the management of the amount of money and the financial conditions, such as those to do with interest rates, credit volumes, discount rates for minimum reserve requirements and others. It is strongly linked to the foreign exchange policy for the control of the amount of money, and to fiscal policy, when the monetary authority must provide the fiscal sector with credits or finance its budget deficits. The instruments used by the monetary policy are discount rates, minimum reserve rates, currency issues, controls over interest rates and the international movement of capitals and others.
It is the Central Bank’s policy being exercised for the control of money, rates of interest and credit conditions. Its instruments are mainly open market operations, minimum reserve requirements and rates of discount.
¿What is fiscal policy?
Fiscal policy is the set of measures implemented by the government intended to guide the economy towards certain targets. The main tools available to the government for this are the management of the volume and destination of public spending. Fiscal policy also includes the ways to finance goverment spending. For example, if the economy is entering a recesive phase, government can reduce taxes and increase spending in order to expand aggregate demand and thus overcome the recesion. If there is a high level of unemployment, it can try creating new jobs and granting temporary subsidies to the unemployed; if there is a high inflation rate, it will try to reduce spending to compensate possible preasures on demand and moderate the increase in prices.
The objectives of policy can be to moderate the economic cycles, to endeavor to raise national income, redistribute income, provide public services, increase employment, etc. Nevertheless, in certain "situations, in order to obtain an objetive of the fiscal policy, this will be conditioned, in the final instance, on the general objectives of the economic policy persued by the goverment at a given moment".
Adjustment of taxation rates or government spending in order to modify aggregate demand.
¿What is monetary supply?
Monetary supply is the amount of money that is availabe to a country’s economy at a given moment. In its most simple form, it corresponds to the amount of cash in the hands of the public and to depositss in current accounts which can be transferred by cheque.
¿What is inflation?
The phenomenon of inflation is defined as a substantial, persistent and sustained increase in the general level of prices in the course of time. We are going to leave behind the conceptual simplicity to explain why this phenomenon can produce very damaging results for the economy in general, and the development of a country.
There are certain arguments according to which inflation has the capacity to promote economic growth, basically in those economies which show low level of income and therefore a small capacity to generate savings which will allow the financing of investment, increase employment and, in general, productive activity. These arguments even consider that the economic authorities, using their capacity to creat currency, can actually increase it, even making prices increase with the hope that this brings greater economic growth, so long as the increase of money is used to stimulate investment. The authors of such arguments suppose that the economic system has enough flexibility in its response, so that what at the begining is an excess of money to finance the productive sector, is compensated when the investment bear fruits because there will be a bigger supply capacity in the economy and this leads, finally, to an adjustment and the stability in medium and long term prices.
But such flexibility is not common in developing economies, so that any action of this type will lead to price instability and loss of control over the economy, becoming an element which generates greater damage to the internal economic environment. Indeed, the uncertainty over the future of the acquisitive power of its income means that economic agents will include as part of their decisions expectations of price increases and so when negotiating they will seek increments in the prices of the goods and services they offer. Therefore, they protect their income by seeking better wages or by imposing higher prices to the products they make, thus inducing a wave of price increases and in general in the prices of the economy as a whole. This result leads, contrary to what was hoped, to discourage internal economic activity.
¿What is deflation?
In simple terms, it is a substantial and persistent decreasing trend in the general level of prices. Generally, it is identified as a situation in which the rythm of economic activity is reduced.
Deflation presents itself when, within an economy, income is depressed and demand weakens and tends to get worse.
If the deflationary process occurs with a persistent reduction in commercial and general business activity it is identified as a recession.
If the situation worsens even more and the reduction of economic activity reaches critical levels, with bankrupt firms, great unemployment and an increase in the scarcity of capital, depression makes its appearence.
With depression there arises a sentiment of pessimisim and a lack of confidence in the economic machinery’s ability to back productive activity, thus making it very difficult for economic agents to take initiatives in order to launch actions which will lead to recovery. To avoid the appearance of external situations that will lead to depression, with damages for all economic agents, governments must correct promptly any trends that may lead to it.
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