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Writer's pictureMarie S.

Analyzing The Government's Monetary Policy To Understand Its Impact On The Economy



Monetary policy, implemented by a country's central bank, is a crucial tool for managing inflation and deflation rates in an economy. The use of expansionary monetary policy, which involves increasing the money supply and lowering interest rates, is typically employed to stimulate economic growth. However, such a policy can lead to inflation if implemented excessively, as the increased money supply can drive up prices. On the other hand, contractionary monetary policy, which involves decreasing the money supply and raising interest rates, is used to curb inflation and slow down economic growth. Such a policy can lead to deflation if implemented excessively, as it can reduce consumer spending and lower prices.


The impact of monetary policy on inflation and deflation rates is exemplified in the case of Liberia. In August 2022, the Central Bank of Liberia (CBL) took a contractionary stance by reducing its policy rate by 500 basis points to 15% to ease inflationary pressures in the economy. While the policy rate was set well above the prevailing inflation rate to control inflation, it also indicated the central bank's cautious approach to managing economic growth. As a result of this policy decision and other fiscal measures, the government's fiscal deficit and public debt ratio improved in 2021.[​1]


It is essential for governments and central banks to carefully analyze the impact of monetary policy on economic indicators, including inflation and deflation rates. Striking the right balance between expansionary and contractionary policies is critical for achieving macroeconomic stability and promoting sustainable economic growth.


Monetary Policy

Monetary policy is the use of money supply and interest rates to influence the economy. The government's central bank, the Central Bank of Liberia (CBL), is responsible for setting monetary policy.


Types of Monetary Policy

There are two main types of monetary policy: expansionary and contractionary. Expansionary monetary policy is used to stimulate the economy, while contractionary monetary policy is used to slow down the economy.


Expansionary Monetary Policy

Expansionary monetary policy is used to increase the money supply and lower interest rates. This makes it easier for businesses to borrow money and invest, and it also makes it easier for consumers to buy goods and services. Expansionary monetary policy can lead to inflation, but it can also help to boost economic growth.


Contractionary Monetary Policy

Contractionary monetary policy is used to decrease the money supply and raise interest rates. This makes it more expensive for businesses to borrow money and invest, and it also makes it more expensive for consumers to buy goods and services. Contractionary monetary policy can help to slow down inflation, but it can also lead to economic recession.


Monetary Policy in Liberia

The CBL has been using a combination of expansionary and contractionary monetary policy in recent years. In 2021, the CBL raised interest rates in an effort to slow down inflation. However, the CBL also lowered interest rates in 2022 in an effort to stimulate the economy.


Impact of Monetary Policy on Inflation

Monetary policy can have a significant impact on inflation. Expansionary monetary policy can lead to inflation, while contractionary monetary policy can help to slow down inflation.


Impact of Monetary Policy on Economic Growth

Monetary policy can also have a significant impact on economic growth. Expansionary monetary policy can help to boost economic growth, while contractionary monetary policy can lead to economic recession.


Government monetary policy plays a pivotal role in influencing inflation and deflation rates within an economy. An expansionary monetary policy, which involves increasing the money supply and lowering interest rates, may result in inflation, as it stimulates spending and demand. In contrast, a contractionary monetary policy, characterized by reducing the money supply and raising interest rates, can lead to deflation, as it restricts spending and demand.


Examining the recent monetary policy stance of Liberia, the Central Bank of Liberia (CBL) maintained a relatively tight monetary policy in 2022, keeping reserve requirements unchanged throughout the year. The policy rate, which is the interest rate at which commercial banks can borrow from the central bank, was held at 20% from January to July 2022, before being reduced to 15% in August 2022. This reduction in the policy rate can be seen as an expansionary monetary policy action aimed at stimulating economic activity.


Nonetheless, the overall monetary policy stance remained restrictive in response to prevailing economic conditions, with commercial banks typically adhering to prudential capital and liquidity requirements​1


Liberia experienced economic growth of 4.8% in 2022, despite challenges such as global inflation and subdued demand in advanced economies. Annual average inflation in Liberia moderated to 7.6% in 2022, compared to 7.8% in the previous year. This containment of inflation is noteworthy, considering the upward pressure from rising global fuel and food prices​2


For 2023, inflation is projected to increase slightly to 7.8% before gradually moderating to 5.5% by 2025. This trend suggests that the CBL's monetary policy measures have been successful in managing inflation within a reasonable range​3


In conclusion, the government's monetary policy plays a vital role in influencing inflation and deflation rates in the economy. The CBL's decisions to maintain a tight monetary policy stance, coupled with adjustments to the policy rate, have contributed to managing inflationary pressures in Liberia. Going forward, it is crucial for policymakers to continuously analyze the government's monetary policy to understand its impact on the economy and make data-driven decisions to ensure stability and sustainable growth.


Sources

[1] "Liberia: Inflation." The World Bank, 2022, www.worldbank.org/en/country/liberia/overview.

[2] "Liberia: Economic Growth." The World Bank, 2022, www.worldbank.org/en/country/liberia/overview.

[3] Liberia Overview: Development news, research, data | World Bank

 

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