By John Severin
The US economy is very large and is almost impossible to control. Much of the US economy is driven by the interest rates that banks give. The lower the interest rate offered the more likely that companies will take out loans and expand their business, therefore adding to the economy. There are 3 basic principals which form the core approach to banks monetary policy.
The first is to "focus on the output gap." When banks try to achieve an overly ambitious output, by allowing many companies to take out loans, they release a lot of money into the economy. This surge of cash can result in inflation which is why banks need to opt for a realistic approach to output. The second principal is called the "Taylor Principal." This approach is very simple if inflation rises by 1 percent then banks should increase the interest they pay customers by 1 percent. Every increase in inflation after that should similarly result in an increase in interest paid. This would result in customers of banks feeling that their money will not lose its value over time due to inflation because banks will pay them an increasing amount for having an account with them. The last principal is to realize that effecting the economy by changing interest rates takes time. Effects of the change may take up to 18 months to see. Banks need predict inflation and respond to it in kind with a change in their interest rates. Monetary policy is not an exact science but if these 3 principals are followed it will help radical changes from sweeping the US economy. Just because the US economy is large does not at all mean that it is without major defects as mentioned above. Sometimes it appears that other countries put our economy on a golden pedestal and they fail to take into account its problems.
The first is to "focus on the output gap." When banks try to achieve an overly ambitious output, by allowing many companies to take out loans, they release a lot of money into the economy. This surge of cash can result in inflation which is why banks need to opt for a realistic approach to output. The second principal is called the "Taylor Principal." This approach is very simple if inflation rises by 1 percent then banks should increase the interest they pay customers by 1 percent. Every increase in inflation after that should similarly result in an increase in interest paid. This would result in customers of banks feeling that their money will not lose its value over time due to inflation because banks will pay them an increasing amount for having an account with them. The last principal is to realize that effecting the economy by changing interest rates takes time. Effects of the change may take up to 18 months to see. Banks need predict inflation and respond to it in kind with a change in their interest rates. Monetary policy is not an exact science but if these 3 principals are followed it will help radical changes from sweeping the US economy. Just because the US economy is large does not at all mean that it is without major defects as mentioned above. Sometimes it appears that other countries put our economy on a golden pedestal and they fail to take into account its problems.
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