The Transmission Mechanism of Monetary Policy

The transmission mechanism of monetary policy is the process that the Central Bank applies monetary policy tools to influence the intermediate target of monetary policy, and then achieve the established policy target. Whether this transmission mechanism of monetary policy is operated perfectly in the country, it affects the regional economic and consequent for the application of monetary policy directly. Monetary policy has 2 types---the expansionary monetary policy and tight monetary policy. In the expansionary monetary policy, the central bank always declines the interest rate to increase the money supply. This measure can increase the liquidity and supply more money back to launch loans. Therefore, people are more inclined to consuming which cause more firms expanding. Thus, promoting the economic growth. As for tight monetary policy, it used to inhibit consumption and investments, which slow the economic growth by decreasing the money supply and raising interest rates. So the tight monetary policy properly cannot be used only if the whole inflation rate is more than the target rate. (Kimberly. A, 28 June 2011) As the Federal Reserve, they applied the quantitative easing policy to stimulate the economy after the 07-09 financial crises. The quantitative easing policy is a non-conventional monetary policy. It is used to stimulate the economy by the central bank when the standard monetary policy is ineffective. The central bank takes a measure to increase the money supply in the bank by purchasing securities or other financial assets. The quantitative easing policy can be used to ensure the inflation rate does not lower than the target. The goal of this policy is that do not let the economy into a recession and prevent further inflation. Forward guidance is a tool used by the Central Bank. It may make a long-term promise especially of the future changes in the interest rate. They may lead investors to use all useful information to make expectations model. The expectations for the future direction of economic will be influenced,due to changes in some financial index. Expectations of monetary policy show the latest changes in interest rate and the money supply. (Demertzis, M, 2006)