write an essay on monetary policy

Essay on Monetary Policy

Monetary Policies And Monetary Policy

Monetary Policies (Introduction) The objective of monetary policy is to reserve the worth of the money by keeping inflation low, stable and predictable that lets Canadians be more confident about the spending and investment choices. It reassures long-term investment in Canada’s economy as well as contributes to continuous job creation and better the production. It helps improve living standard. Canada’s monetary policy outline consists of two key components working together and reinforcing each

Monetary Policy Rules And Monetary Policies

Monetary policy rules are a fundamental part of the central bank models and are often refined to maximize economic welfare, specific to that country. Monetary policy rules are a methodical response of monetary policy events in the economy. Essentially, it can be thought of as a numeric equation, which determines the appropriate level for the central bank’s policy instrument to be a function of one or more economic variables that describe the state of the economy. It is imperative that economies

I. Introduction Monetary policy rules are a fundamental part of the central bank models and are often refined to maximize economic welfare, specific to that country. Monetary policy rules are a methodical response of monetary policy events in the economy. Essentially, it can be thought of as a numeric equation, which determines the appropriate level for the central bank’s policy instrument to be a function of one or more economic variables that describe the state of the economy. It is imperative

Monetary And Fiscal Policy : Monetary Policy

Monetary and fiscal policy Introduction Fiscal policy is defined as the power that the federal government poses that enables it to impose taxes and also spend to achieve its goals in the economy. On the other hand, the monetary policy is maintaining the programs that try to increase the nation’s level of business through regulation the supply of money and credit. Currently, one of the most important roles of the federal government is to regulate and also ensure that there is stability in the economy

Monetary Policy

Monetary Policy at the Local and Federal Level & Impact in a Recession Monetary policy, in the short run, has an impact toward the demand for goods and services. That is, monetary policy has a distinct influence over inflation and other economic factors, not only at the federal level, but at the state and citywide levels. Monetary policy will influence the financial conditions facing firms and households in the environment, even at the micro level. Thus, employees who produce goods and services are

Fiscal Policy And Monetary Policy

Nowadays, economic growth and stability is the goal that governments aim to achieve. There are two main ways to achieve this purpose: fiscal policy and monetary policy. Monetary policy is a kind of macroeconomic policy lead by the central bank. Expansionary monetary policies can help boost the economy but it will cause inflation. There are two approaches to control money supply; there are price and quantity. Price represents interest rates and quantity means amount of money quantity. After financial

Fiscal Policy and Monetary Policy

Fiscal policy is the governments spending policies, which influences the conditions economy as a whole. With this policy, regulators can improve unemployment rates; stabilize business cycles, control inflation, and interest rates to control the economy. The government adjusts the spending and tax rates to influence the nation’s economy. The idea is to find the balance between public spending and changing tax rates, by increasing or lowering taxes may cause the risk of causing inflation to rise. If

The government in times of economic recession has responsibility to take action, engaging in expansionary economic policies is the action my paper will discuss. The types of economic expansion include Fiscal Policy, and Monetary Policy, the expansion of the two policies allows the government to adjust taxes, and government spending. Harry Truman once quoted “It’s a recession when your neighbor loses his job: it’s a depression when you lose yours.” (The economy perspective, the banker 's banker. (1998

Monetary Policy And Fiscal Policy

The Federal Government uses the monetary policy and fiscal policy to establish and determine the best way to manage the economy. Monetary policy is used by the Federal Reserve to manage the money supply. This includes credit, cash, check, and money market mutual funds, with loans, bonds, and mortgages being the most important. This policy can be broken into two categories: monetary restraint and monetary expansion. As it states, one is trying to restrain the market while the other expresses expanding

is fiscal and monetary policy to find out a way to find the economic. It is macroeconomic policy that pursues to enlarge the money supply to boost economic growth or combat inflation. One of the form is fiscal policy of expansionary policy, which comes in the method of tax cuts, discounts and increased government spending. Expansionary policies do come from central banks, which focus on cumulative the money supply in the economy. Now let look at the break down of expansionary policy which deal with

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monetary policy

monetary policy , measures employed by governments to influence economic activity, specifically by manipulating the supplies of money and credit and by altering rates of interest .

(Read Milton Friedman’s Britannica entry on money.)

The usual goals of monetary policy are to achieve or maintain full employment, to achieve or maintain a high rate of economic growth , and to stabilize prices and wages. Until the early 20th century, monetary policy was thought by most experts to be of little use in influencing the economy. Inflationary trends after World War II , however, caused governments to adopt measures that reduced inflation by restricting growth in the money supply.

Monetary policy is the domain of a nation’s central bank . The Federal Reserve System (commonly called the Fed) in the United States and the Bank of England of Great Britain are two of the largest such “banks” in the world. Although there are some differences between them, the fundamentals of their operations are almost identical and are useful for highlighting the various measures that can constitute monetary policy.

The Fed uses three main instruments in regulating the money supply: open-market operations , the discount rate , and reserve requirements. The first is by far the most important. By buying or selling government securities (usually bonds ), the Fed—or a central bank—affects the money supply and interest rates. If, for example, the Fed buys government securities, it pays with a check drawn on itself. This action creates money in the form of additional deposits from the sale of the securities by commercial banks. By adding to the cash reserves of the commercial banks, then, the Fed enables those banks to increase their lending capacity. Consequently, the additional demand for government bonds bids up their price and thus reduces their yield (i.e., interest rates). The purpose of this operation is to ease the availability of credit and to reduce interest rates, which thereby encourages businesses to invest more and consumers to spend more. The selling of government securities by the Fed achieves the opposite effect of contracting the money supply and increasing interest rates.

The second tool is the discount rate , which is the interest rate at which the Fed (or a central bank) lends to commercial banks. An increase in the discount rate reduces the amount of lending made by banks. In most countries the discount rate is used as a signal, in that a change in the discount rate will typically be followed by a similar change in the interest rates charged by commercial banks.

The third tool regards changes in reserve requirements. Commercial banks by law hold a specific percentage of their deposits and required reserves with the Fed (or a central bank). These are held either in the form of non-interest-bearing reserves or as cash. This reserve requirement acts as a brake on the lending operations of the commercial banks: by increasing or decreasing this reserve-ratio requirement, the Fed can influence the amount of money available for lending and hence the money supply. This tool is rarely used, however, because it is so blunt. The Bank of England and most other central banks also employ a number of other tools, such as “treasury directive” regulation of installment purchasing and “special deposits.”

Historically, under the gold standard of currency valuation, the primary goal of monetary policy was to protect the central banks’ gold reserves. When a nation’s balance of payments was in deficit, an outflow of gold to other nations would result. In order to stem this drain, the central bank would raise the discount rate and then undertake open-market operations to reduce the total quantity of money in the country. This would lead to a fall in prices, income, and employment and reduce the demand for imports and thus would correct the trade imbalance. The reverse process was used to correct a balance of payments surplus.

The inflationary conditions of the late 1960s and ’70s, when inflation in the Western world rose to a level three times the 1950–70 average, revived interest in monetary policy. Monetarists such as Harry G. Johnson , Milton Friedman , and Friedrich Hayek explored the links between the growth in money supply and the acceleration of inflation. They argued that tight control of money-supply growth was a far more effective way of squeezing inflation out of the system than were demand-management policies. Monetary policy is still used as a means of controlling a national economy’s cyclical fluctuations.

The Monetary Policy Essay Prize .

The Monetary Policy Essay Prize 2023-4. By the Institute of Economic Affairs, the Institute of International Monetary Research, and the Vinson Centre What causes high inflation, and is the Bank of England responsible for the current inflation episode? If so, how would you make it more accountable?   The Submission and Style Requirements Entries should be no longer than 2,500 words long. Entries should include a bibliography and Harvard style referencing. References will count towards the word total, but the bibliography will not. The text should be double spaced, on A4 pages, in Arial size 12 font. How to Enter This year, the Monetary Policy Essay Prize will be divided into two separate competitions, the first for sixth formers , the second for undergraduates . The competitions are  free to enter, and open to both  UK and non-UK residents. However, all entrants must be able to attend the semi-finals and final in person in order to compete. Entries for the 2024 competition closed on 26 January 2024. Logistics The entries will be reviewed by a panel of judges, and the top entries will be invited to semi-finals at the Vinson Centre at the University of Buckingham in February 2024. The top participants from the semi-finals will then be invited to the final at the Institute of Economic Affairs in London in March 2024. Prizes For Sixth Form competition, £1,000 will be awarded to first prize, and £500 each to two runners up. For the Undergraduate competition, £2,000 will be awarded to first prize, and £1,000 each to two runners up. The entries will be judged on the criteria of knowledge and understanding of the economic issues raised by the challenge, use of resources, the quality and clarity of the argument and analysis presented, and the degree of originality and insight displayed. They will not be judged on the basis of adherence to a particular perspective regardless of quality or the other considerations set out. About IIMR The purpose of the Institute of International Monetary Research is to demonstrate and bring to public attention the strong relationship between the quantity of money on the one hand, and the levels of national income and expenditure on the other. The Institute – which is associated with the University of Buckingham in England – was set up in 2014, in the aftermath of the Great Financial Crisis (a.k.a., “the Great Recession”) of 2007 – 2009. It is an educational charity. About IEA The IEA is the UK’s original free-market think-tank, founded in 1955. Our mission is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems. As part of this, the IEA runs an extensive student outreach programme including internships, summer schools, seminars and competitions. The IEA is an educational charity (No CC 235 351) and independent research institute limited by guarantee. Ideas and policies produced by the Institute are freely available from our website. The Institute is entirely independent of any political party or group, and is entirely funded by voluntary donations from individuals, companies and foundations. About the Vinson Centre The Vinson Centre for the public understanding of economics and entrepreneurship is a space for research and knowledge exchange at the University of Buckingham where individuals and teams come together to pursue exciting projects in novel ways. 2024 Winners On 25th March 2024 we ran the final for the sixth year of our Monetary Policy Essay Prize in conjunction with the Institute of International Monetary Research and the Vinson Centre. The undergraduate prize was won by Alberto Ornaghi (LSE). Christian Bulmer and Hubert Kucharski came in as the two runners up. The sixth form prize was won by Niccolo Silvestri (King’s College School, Wimbledon). YaXi Zheng and Tej Venigalla came in as the two runners up.

The IEA is an educational charity and free market think tank .

Our mission is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems.

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Home — Essay Samples — Economics — Political Economy — Monetary Policy

Essays on Monetary Policy

Monetary policy is an important tool used by central banks to manage the money supply and achieve economic goals such as price stability, full employment, and economic growth. It involves the use of interest rates, open market operations, and reserve requirements to influence the level of economic activity. Given its significance in shaping the overall economic landscape, there are numerous topics that can be explored in essays related to monetary policy.

Importance of the Topic

Understanding monetary policy is crucial for individuals, businesses, and policymakers alike. For individuals, it can affect their borrowing and saving decisions, as well as their purchasing power. For businesses, it can impact their investment decisions and access to credit. For policymakers, it is essential for making informed decisions on interest rates and other monetary policy tools to achieve macroeconomic objectives.

Advice on Choosing a Topic

When selecting a monetary policy essay topic, it is important to consider current events and trends in the economy. Some potential areas of focus could include the impact of monetary policy on inflation, the effectiveness of unconventional monetary policies such as quantitative easing, or the role of central banks in financial stability. Additionally, exploring the relationship between monetary policy and other economic variables such as exchange rates, asset prices, and economic growth can provide valuable insights.

Another approach could be to analyze the historical evolution of monetary policy and its impact on different economic periods. This could involve examining the effectiveness of various monetary policy regimes, such as fixed exchange rates versus floating exchange rates, or the implications of different monetary policy rules such as inflation targeting or nominal GDP targeting.

Furthermore, essays could delve into the challenges and limitations of monetary policy in the current global economic environment. This might include discussing the constraints faced by central banks in the aftermath of the 2008 financial crisis, as well as the implications of low and negative interest rates on monetary policy effectiveness.

Monetary policy is a multifaceted topic with a wide range of potential essay topics to explore. Whether delving into contemporary issues, historical perspectives, or theoretical debates, there is no shortage of interesting and relevant subjects to examine. By choosing a well-defined and relevant topic, students and researchers can contribute to the ongoing discourse on monetary policy and deepen their understanding of its impact on the economy. As the economic landscape continues to evolve, the study of monetary policy will remain a crucial area of research and analysis.

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The Monetary Crisis in Europe

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How Do Modern Monetary Policies Work? Essay

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Introduction

Indicators of monetary policy, how the monetary policy works, works cited.

Globalization has made the world a global village and thus any country’s economy is affected both by its internal monetary policies and those of other countries it interacts with. Depending on the way these monetary policies are made they can work toward developing the economy of one country to the detriment of the others or promote economic growth in both the country where they are enacted and to other trading countries.

The United States of America has experienced economic expansion for a very long period (from 1990 to 2000) until the last half of the year 2000 when the country’s economy growth became slow and sluggish. In order to contain the slow growth and improve the economy of the country “the Federal Reserve between mid-1999 and May 2000 raised the target for the federal funds rate to 6½ % from 4¾ %”( Labonte & Makinen 7).

his did not auger well as the economy growth continued to decline and thus the policies had to be loosened in order to allow more production and spending for the economy to grow.

Government policies that are aimed at controlling the supply of money in the market through the Central Bank make up monetary policies.

In the legislation and enacting of monetary policies several bodies coordinate together in order to achieve an acceptable money supply as not only does it affect the country’s economy but also other countries economies, which trades with the United States of America. The major banks making policies in the United States of America are however two (both the nation’s Central Bank and the Federal Reserve).

In relation to the United States of America, we can define monetary policies as those policies that “consist of the directives, policies, pronouncements, and actions of the Federal Reserve that affect aggregate demand or national spending” (Labonte & Makinen 8). Monetary policies works at either increasing or decreasing the supply of the money in the market influencing how trade and spending goes on within a country.

The only unfair characteristic of monetary policies is that they are short term in nature since their enactments are usually designed only to solve a short term crisis. In short the monetary policy tries to solve economic crisis and once the normal economic environment is regained the monetary policies are also adjusted to suit the situation.

Monetary policies try to solve macro economic issues such as spending, income levels, unemployment, and inflation among other macroeconomic factors. Evidence showing monetary polices trends can be described by the fact that:

Between January 3, 2001, and June 25, 2003, the target rate for federal funds was reduced to 1% from 6½%. This policy was reversed beginning June 30, 2004. In 17 equal increments of ¼% ending on June 29, 2006, the target rate was raised to 5¼% from a base of 1%. No additional changes were made at the three subsequent meetings. (Labonte & Makinen 4)

In order to understand how monetary policies work it is advisable to understand its two indicators.

Money Supply

A common market rule is that when the supply of a commodity decreases its demand increases resulting in increased prices and the opposite happens when the supply is high the demand decreases thus driving the prices down. This same law also applies to the supply of the money in the market. Most of the times, monetary policies are described either as easy if in influences an increased money supply and tight if its main aim is to reduce the money supply.

Interest Rates

In his interest theory, John Maynard Keynes argued that interest rate is monetary phenomena determined in the money market but not influenced by savings as classical economists used to argue. He argued that not all people who save that do so with an intention of earning interest thus it should be in the monetary market where funds are borrowed and their rates determined. Thus, changes in money supply (whether an increase or a decrease) leads to an increase or a decrease in the cost of the money.

The changes in interest rates are important to the government as they influence spending in an economy thus creating or reducing employment. However, experts warn that the interest rates experienced due to the changes in aggregate demand and supply of the money are not the real market rates; the real market rates should be the existing market rates less inflation rates in the country. It is thus assumed that a high economic growth reduces interest rates in the short run.

Given that countries have future expectations of how inflation rates will be the fall in market rates is always seen as a fall in the real interest rates. However, market rates can change for other reasons for example an increase in income increases the market interest rates thus increasing the demand for money since more people can afford the money and the public expects lower inflations in future (Schabert 17).

Monetary policies works through the following instruments which either increases or decreases the supply of money in the market as it is explained below.

Open Market Operations

To increase or decrease the supply of money in the market, the Federal Reserve can engage in open market operations; this involves selling and buying of bonds in the market.

When the federal Bank engages in selling the bonds or securities it aims at reducing the money supply in the market to avoid inflation of the money; the opposite occurs if the federal bank realizes that the money supply in the market is less as it repurchases the bonds and the securities thus making more money available in the market and this helps in ensuring that the commodity prices remain at a stable position by increasing both the money supply and the aggregate demand (Taylor 4).

Reserves Deposit Requirement

The government through the federal government can also increase or decrease the required reserve deposits that the commercial banks in the country deposits in the federal government in order to control an economic problem which may be brought about by the existing economic conditions.

In order to reduce money supply in the market, the Federal Bank instructs the regional or commercial banks to increase their reserve requirements; this increases the amount of money withheld and in return reduces the amount of money which can be lend to the customers thus reducing the money supply.

The lowering of the reserve deposit required in these banks by the Federal Bank works in the opposite way. In order to meet these Fed requirements, banks lend among themselves creating a multiplier effect and the rate on such loans determines how loose or tight the monetary policy at that time (Feinman, Deschler & Hinkelmann 1).

Discount Rate

Federal Reserve lending rates to commercial banks are described as discount rates. An increase in the discount rate makes the cost of borrowing increase thus reducing the amount of money which the Federal Reserve can lend to the commercial banks within the state. The high interest rates are transferred down to the customers and the high rates discourage borrowing thus reducing the money supply in the market (U S Department of State 28).

Interaction between Central Bank, the Treasury, and the Financial System

The Central Bank is a special bank within the ministry of finance but independent from interference by the executive. The bank has the mandate to preserve financial stability and enhance financial development by controlling the money supply in the market. Its’ autonomy can be described in terms of;

the ability to set the terms and conditions on the items in the central bank’s balance sheet – this is essential for the conduct of monetary policy; having the means to bear any losses that arise from central bank operations and having appropriate rules to allocate profits (including rules that govern the accumulation of capital and reserves); and the ability to cover operating expenses, and in particular to set salaries (typically the single largest component of operating costs) in a manner that allows the Central Bank to attract and retain the professional talent it requires (Boehm 59).

There have been interactions between the treasury and the federal reserve board in an attempt by the government to overhaul the regulatory system but some Fed officials were seeing it as an attempt by the government to interfere with the independence of the bank and thus there was no way they could accept.

They argue that the Fed was established by the congress thus it is not part of the executive thus interference should no be expected from the treasury (Torres & Schmidt 1). The interaction between the central bank, the treasury, and the financial institutions is best described in the way the monetary policies work and the role played by each.

Policy Proposals Relating to Reforming the Financial System

One of the proposals being forwarded by the congress is that of establishing a new systemic risk regulator bearing in mind the country is just recovering from the economic crisis. The regulator is expected to supervise the growth of the financial institutions.

There has also been the proposal of changing how the Federal Bank functions. This has not augured well as it would curtail the independence of the Federal Bank and make it prone to political interference.

While many think that this will work well in the long run it may work against the goals of making the financial institutions and monetary policies effective as political interests might be fulfilled to the expense of American citizens. There have been further proposals from the House and the Senate for the creation of a Risk Based Systemic Fund whose source would be from the institutions. While the policy might be good, it is not without a flaw since it fails to address the appropriate levels through which the financial institutions can be evaluated.

Other proposals have been aimed at making stricter standards on capital and liquidity requirements among the most risky institutions. As the United States of America recovers from the economic crisis there have been calls to create or establish a mechanism through which failing financial institutions can be rescued before they can file into bankruptcy through receivership so as to reduce the uncertainties in the monetary system (Acharya, Cooley, Richardson, & Ingo 16).

Finally, the executive has had interests in controlling the actions of the Fed and thus they had been proposing for law reviews which would allow the central bank become the lead regulator for all the financial institutions (Torres & Schmidt 1).

From the study we can conclude that monetary policies are ways through which the government regulates the supply of money in the bank and while the policies are good they are only enacted for short term purposes as the economy is never static. Thus, policies also need to evolve and should be legislated in a way that suits the prevailing economic conditions.

Acharya, Viral, Cooley F. Thomas; Richardson, Matthew., & Ingo, Walter. “ Real Time Solutions for US Financial Reform. ” VoxEU.org , 2009. Web.

Boehm, Moser. “ The Relationship between the Central Bank and the Government. ” Bis , 2006. Web.

Feinman, Joshua; Deschler Jana., & Hinkelmann, Christoph. “ Reserve Requirements: History, Current Practice, and Potential Reform. ” Federalreserve , 1993. Web.

Labonte, Marc., & Makinen, Gail. “Monetary Policy: Current Policy and Conditions”. CRS Report for Congress. The Library of Congress, 2006.

Schabert, Andreas. Money supply and the implementation of interest rate Targets: Working Paper Series . London: European Central Bank. 2005

Taylor, John. “ Expectations, Open Market Operations, and Changes in the Federal Funds Rate. ” Stanford University. 2001. Web.

Torres, Craig., & Schmidt Robert. “Fed Rejects Geithner Request for Study of Governance Structure.” Bloomberg, 2009. Web.

U.S. Department of State. “ Monetary and Fiscal Policy. ” Countrystudies , 2010.

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Article Contents

I. introduction, ii. the investment multiplier, the marginal efficiency of capital and unemployment, iii. probability, risk, and long-term expectations, iv. monetary policy and the safe interest rate, v. summary and conclusion, keynes's theory of monetary policy: an essay in historical reconstruction.

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Edwin Dickens, Keynes's Theory of Monetary Policy: An Essay In Historical Reconstruction, Contributions to Political Economy , Volume 30, Issue 1, June 2011, Pages 1–11, https://doi.org/10.1093/cpe/bzr001

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Keynes's theory of monetary policy is composed of three concepts—namely, the investment multiplier, the marginal efficiency of capital and the interest rate. By analyzing how these three concepts interact in the short period, Keynes explains why he is opposed to countercyclical monetary policies. And by analyzing how they interact in the long period, he explains why the economy tends to fluctuate around a long-period equilibrium position that is characterized by unemployment. Keynes concludes that the sole objective of the monetary authority should be to use its influence over the interest rate to dislodge the economy from its long-period equilibrium position that is characterized by unemployment and propel it toward a long-period equilibrium position that is characterized by full employment.

Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement which can be made in the technique of monetary management ( Keynes, 1936 , p.206).

The paper is organized as follows. In Section II, I use Keynes's concepts of the investment multiplier and the marginal efficiency of capital to specify the long-period equilibrium position of the economy which is characterized by unemployment.

In Section III, in order to explain why the economy fluctuates around a long-period equilibrium position characterized by unemployment, I specify the difference, as well as the relationship, between Keynes's concepts of probability and risk and the orthodox ones.

In Section IV, I use Keynes's concept of the interest rate to explain the effects of monetary policy, both in the short-period and in the long-period.

Lastly, in Section V, I provide a summary and conclusion.

Let N s be the supply of labor and N d the demand for labor, or the actual volume of employment ( n ). We can then define full-employment ( n o ) as N d / N s = 1; unemployment ( n k ) as N d / N s < 1; and the unemployment rate as 1 − n k .

For Keynes (1936 , pp. 25–29 ff. ), n is determined by the aggregate level of output ( Y ) and the productivity of labor ( P ). That is to say, by definition P = Y/N d . Re-arranging terms, N d = Y/P . Substituting into our definition of n , we thus get n = Y/P N s .

Equation (6) is derived from the law of large numbers and incorrectly assumes that the underlying causal structure that determines the outcome of investment projects is known in the same way that the underlying causal structure that determines the outcomes of coin tosses or turns of the roulette wheel is known. In fact, the underlying causal structure that determines the outcome of investment projects is either knowable but unknown or, as Keynes (1937a , b , c ) argues, unknowable. Following Markowitz (1959 , p. 39 ff. ), orthodox economists take this fact into account by interpreting equation (6) in terms of the principle of non-sufficient reason.

According to the principle of non-sufficient reason, if investors do not have a reason to assign different probabilities to a set of possible outcomes, they must assign them equal probabilities. Therefore, if qualms about factors that are knowable but unknown or unknowable undermine the confidence of investors in their calculations of the outcome of prospective investment projects, orthodox economists instruct them to assign equal probabilities to the outcomes they fear may result from these factors, with the sum of assigned probabilities being equal to one. Orthodox economists thus interpret the expected profit ( E o ) in equation (5) as the mathematical mean of the sum of the products of all possible outcomes of investment projects and their probability. They then interpret the risk of investment projects as the variability (or standard deviation), of the sum of the products of all their possible outcomes and their probability, around the mathematical mean.

Equation (9) can be read as ‘proposition a on the hypothesis h · p o has a probability p k ’. Alternatively, it can be read as ‘the conclusion a can be inferred from the evidence h · p o with a probability of p k ’.

If w ( a|h · p o ) = 1, then the hypothesis h · p o implies the conclusion a with certainty. If w ( a|h · p o ) = 0, then hypothesis h implies that the conclusion a is impossible. If 0 < w ( a|h · p o ) < 1, then there is a probability relation of degree p k between a and h · p o .

In short, Keynes's concept of probability ( p k ), as formulated in equation (9), encompasses the orthodox concept of probability ( p o ), as formulated in equation (6), and the relationship between the two is mediated by Keynes's concept of the weight of arguments ( w ).

For Keynes (1921 , p. 77–80), w measures the vague but pervasive sense of inadequacy that investors feel when they compare what they know with what they think they ought to know in order to make informed investment decisions. If w = 1, then the interpretation of equation 6 in terms of the principle of non-sufficient reason has quelled investors’ sense of inadequacy, p o is completely dominate and equation (9), and p k = p o . If 0 < w < 1, then investors do not suppress the fact that setting w equal to one leads to absurdities (see Dickens (2008 , p. 224–225) for an explanation of why), and the factors making the underlying causal structure determining the outcome of investment projects knowable but unknown or unknowable take the form of propositions in h which weigh against p o 's dominance, so that p k < p o .

Even if w = 1, p k is still less than p o once we add Keynes's concept of risk, as formulated in equation (8), to w as a mediating factor between p k and p o , and thereby obtain equation (7). Keynes (1921 , p. 348) formulates equation (7) in such a way that two conditions are met: If p o = 1 and w = 1, then p k = 1; and if p o = 0 and w = 0, then p k = 0. It follows that, if 0 < w < 1 and/or 0 < p o < 1 (so that q = 1 − p o has a value between zero and one), then p k < p o . Of course, p o = m / z = 1 only if there is apodictic certainty about the underlying causal structure that determines the outcome of investment projects, in the way that there is apodictic certainty about the outcome of tossing a two-headed coin—hardly a relevant case to evaluating prospective investment projects.

If p k < p o , then we know from equations (5), (4), (1), and (2), respectively, that E k < E o → I k < I o → Y k < Y o → 1 − n k > 0. In short, if Keynes's concepts of probability and risk are correct, the long-period equilibrium position of the economy is characterized by unemployment.

The monetary authority directly controls the short-term interest rate. 5 With ‘a modest measure of persistence and consistency of purpose,’ Keynes (1936 , p. 204) asserts that the monetary authority can also influence the long-term interest rate. 6 Orthodox economists (see, for example, Ingersoll, 1989 , pp. 173–178) have accepted Keynes's assertion, taking it to mean that the long-term interest rate is the mathematical mean of the sum of the products of all possible outcomes of the short-term interest rate and their probability. For example, the yield on the 10-year bond allegedly equals the mathematical mean of the expected yields on 3-month securities for the next 10 years, plus an illiquidity premium which reflects the orthodox concept of risk. Unfortunately, orthodox economists ignore the difference between Keynes's concepts of probability and risk and the orthodox ones, and reject the classical long-period method, which Keynes uses to distinguish between the long-period equilibrium values of variables and their short-period values. To reconstruct Keynes's theory of monetary policy, these oversights must be rectified.

For Keynes (1936 , pp. 202, 206 and 313–320), the short-period fluctuations of r a around r s are strictly limited to ‘the difference between the[ir] squares’. 9 In contrast, since the stock market determines the actual expected profit ( E a ) in the short-period, the short-period fluctuations of I a and Y a around I k and Y k are unlimited. 10 Therefore, efforts by the monetary authority to stabilize the short-period fluctuations of the economy are futile for two reasons. First, any drastic changes that the monetary authority makes in the short-term interest rate simply cause a more steeply sloped yield curve as r a reaches the limits of its variability around r s . Second, such drastic changes in the short-term interest rate threaten to shatter the confidence of investors in their calculations of E a . If drastic enough, such changes may thus cause a severe recession as investors contemplate trillions of dollars of losses on their bets in the stock market.

If the monetary authority has the discretion to change the short-term interest rate, investors must take into account the possibility that future investment projects, with lower financing costs, will compete against investment projects undertaken today at higher financing costs. As a result, h 2 weighs more heavily than does h 1 against the dominate proposition for undertaking investments projects ( p o ). That is to say, w 1 > w 2 . It follows from equation (15) that p k1 > p k2 → E k1 > E k2 ; and from equation (16) that r s1 < r s2 .

Looking backward, we observe long-run trends shaping economic events. The confidence to undertake investment projects depends upon our ability to project these trends into the future. The problem is that we know these trends are not governed by natural laws but are instead the result of the series of investment projects undertaken by forward-looking investors in the past. In every short-period situation in which such investment projects were undertaken, the long-run trends of the economy would have taken off in a different direction, if those investment projects had not been undertaken.

For this reason, investors take a two-step approach to the evaluation of prospective investment projects. First, they project long-run trends into the future by assigning probabilities to the likelihood of their continuance, and thereby calculate the expected profit ( E o ). 11 Second, they contemplate the degree to which the principle of non-sufficient reason captures their uncertainty about the degree to which knowable but unknown or unknowable factors may cause the future trends of the economy to differ from past ones, and thereby calculate the expected profit ( E k ).

Monetary policy is a factor that has shaped the long-run trends of the economy. It is thus necessary for investors to assign a probability to the likelihood that the monetary authority will continue to act in the same way that it has in the past, and incorporate it into the calculation of E o . If the monetary authority has the discretion to act differently in the future than it has in the past, investors are compelled to contemplate monetary policy itself as a knowable but unknown or unknowable factor that may cause future trends of the economy to differ from past ones, and thus take it into account as a factor that makes E k < E o . If the monetary authority would make a credible commitment to buying and selling at stated prices gilt-edged bonds of all maturities, this element of uncertainty would be alleviated, thereby reducing the difference between E k and E o . The purpose of this paper has been to show that, as a result, the long-period equilibrium position of the economy would be characterized by less unemployment.

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Ricardo and his successors overlook the fact that even in the long period the volume of employment is not necessarily full but is capable of varying, and that to every banking [monetary] policy there corresponds a different long-period level of employment, so that there are a number of positions of long-period equilibrium corresponding to different conceivable interest policies on the part of the monetary authority ( Keynes, 1936 , p.191).

Keynes applies equation (3) to capital assets rather than investment projects, and thereby obtains his concept of the marginal efficiency of capital. As Garegnani (1983) demonstrates, this application is incorrect because it implies that capital is a factor of production that yields a marginal product when plugged into a (aggregate) production function. However, as Pasinetti (1974 , pp. 37–38) demonstrates, equation (3) still applies to investment projects. To make clear that I am using equation (3) in the valid sense of applying to investment projects, I drop the concept of the marginal efficiency of capital in favor of the concept of net present value.

Dickens (2008 , pp. 224–225) draws upon the literature in behavioral finance to explain why the orthodox concept of expected profit ( E o ) leads to absurdities.

The formulation of Keynes's concept of probability ( p k ) in equation (9) differs from its formulation in equation (7) because, at this point in the argument, we are abstracting from the concept of risk, as formulated in equation (8) . As shown below, equation (7) results from the combination of equations (8) and (9) .

This proposition preempts the analysis of the determination of interest rates by the schedule of liquidity preference and the supply of money.

‘The short-term interest rate’ denotes an index of all market yields on high-quality securities of short maturity and ‘the long-term interest rate’ denotes an index of all market yields on high-quality bonds of long maturity. Using such indexes is legitimate because all short-term market yields move in tandem, as do all long-term market yields. However, the short-term interest rate and the long-term interest rate do not move in tandem. Sometimes the yield curve is positively sloped, sometimes inverted, and sometimes flat.

The owners of wealth will then weigh the lack of ‘liquidity’ of different capital equipments … as a medium in which to hold wealth against the best available estimate of their prospective yields after allowing for risk [ E o ]. The liquidity-premium, it will be observed, is partly similar to the risk-premium [understood as the variability (or standard deviation), of the sum of the products of all possible outcomes and their probability, around the mathematical mean] but partly different;–the difference corresponding to the difference between the best estimates we can make of probabilities and the confidence with which we make them. * When we are dealing, in earlier chapters, with the estimation of prospective yield, we did not enter into detail as to how the estimation is made: and to avoid complicating the argument, we did not distinguish differences in liquidity from differences in risk proper. It is evident, however, that in calculating the own-rate of interest we must allow for both ( Keynes 1936 , p.240).

Tobin's q proposes that the expected profit from investment projects, as determined in the stock market ( E a ), influences long-term expectations ( E k ), and thus the aggregate rate of investment undertaken in long-period equilibrium ( I k ). In contrast, as formulated in equation (1 1), E a influences short-term expectations, and thus the pace at which I k is implemented in the short-period.

For example, if the safe long-term interest rate ( r s ) is 4%, then the actual long-term interest rate ( r a ) is limited to a range of 0.04 − (0.04) 2 = 3.84% to 0.04 + (0.04) 2 = 4.16%. If r s is 2%, then r a is limited to a range of 0.02 − (0.02) 2 = 1.96% to 0.02 + (0.02) 2 = 2.04%.

The short-period fluctuations of n a around n k have an upper bound, given by the supply of labor. However, this does not limit the short-period fluctuations of I a and Y a around I k and Y k ; it simply defines the point at which those fluctuations cause what Keynes (1936 , pp.119 and 303) calls ‘true inflation’. In other words, for Keynes, inflation is a short-period phenomenon.

D'Orlando (2005) also argues that probabilistic, as opposed to deterministic, dynamic models are compatible with the classical long-period method.

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Monetary Policy Higher Education Questions

Help students understand monetary policy and currencies through these essay and discussion questions.

Why are economies around the world so interconnected? What are the differences between expansionary and contractionary monetary policies? What are the consequences of each? With the largest economy, are the policies of the United States sufficient to promote stability of the global economy? Why or why not?

• In what ways is the United States vulnerable to financial pressure from other countries? What factors mitigate that vulnerability?
• What can the Great Recession tell us about the risks of future global financial crises?
• How did the United Kingdom’s situation in 1956 make it vulnerable to financial pressure from the United States?

What is the role central banks play in the global economy? In particular, what is the role of the U.S. Federal Reserve (also known as “the Fed”)? What is its legal mandate? To what extent have the policies of the Federal Reserve proven to be useful tools in ensuring global financial stability? Defend your answer by citing specific examples.

• How does the Federal Reserve conduct monetary policy?
• How does the Fed influence money supply?
• How does the Fed influence interest rates?
• How did the Great Recession of 2008 impact the world? How did the Fed address these challenges?

How did the U.S. dollar become the most popular currency in the world? Why is the U.S. dollar so desirable to other countries, considering they have their own currency? How important is the role of the dollar to U.S. wealth and power? Evaluate the benefits of maintaining the global role of the U.S. dollar.

• What were the advantages and disadvantages of the gold standard?
• What is de-dollarization?
• How does the global role of the dollar benefit the United States?
• How does the global role of the dollar benefit the international community?

Why do most countries have their own currency, rather than sharing with other countries? Why do exchange rates between currencies fluctuate? Evaluate the advantages and disadvantages of a world with one currency. Use the European Union (and the Euro) as a case study.

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Role of monetary policy in economic growth and development: from theory to empirical evidence

Asian Journal of Economics and Banking

ISSN : 2615-9821

Article publication date: 11 May 2022

Issue publication date: 24 March 2023

This article examines the effects of credit to private sector on the business and trade activities. The effectiveness of rapid expansion in public and private borrowing through state's intervention after COVID-19 pandemic has been assessed in this study.

Design/methodology/approach

The model to determine the role of credit expansion is based on four equations estimated through panel least square technique on 18 years data of 186 countries.

It is concluded that credit to private sector and external debt improve the investment in infrastructure, which is a significant determinant of gross domestic product growth. Empirical evidences corroborate that higher number of firms using banks to finance their investment and the volume of broad money determine the magnitude of credit to private sector.

Originality/value

This study explores some new evidences and aspects of the credit financing which have not been discussed in this way before.

• Public private partnership
• Financial inclusion
• Domestic credit to private sector
• Neoclassical liberalism
• Ordoliberalism
• Panel least square

Mehar, M.A. (2023), "Role of monetary policy in economic growth and development: from theory to empirical evidence", Asian Journal of Economics and Banking , Vol. 7 No. 1, pp. 99-120. https://doi.org/10.1108/AJEB-12-2021-0148

Emerald Publishing Limited

Copyright © 2022, Muhammad Ayub Mehar

Published in Asian Journal of Economics and Banking . Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/legalcode

1. Introduction: effectiveness of monetary policy

Monetary policy is considered a part of economic planning and strategies to provide an environment for economic development and welfare of general public. A usual way to test the effectiveness of monetary policy is to test the impacts of interest rates on gross domestic product (GDP) growth, investment and inflation. The traditional Liquidity-money (LM) curve approach is also adopted to explain the implications of monetary policy.

For a desirable outcome of monetary policy, the nominal rate of GDP growth should not be less than the rate of inflation. If the effect of monetary easing on inflation is stronger than its effect on growth, it will lead to higher level of poverty. In other words, a positive real rate of growth in GDP is the indicator of an effective monetary policy. This target can be achieved if monetary expansion leads the enhancement in business activities. The volume of external trade and creation of new business entities are the indicators of enhancement in business activities, while a higher rate of GDP growth can lead to alleviation of poverty. Baily and Okun (1965) have concluded that higher economic growth in terms of GDP reduces the unemployment.

Mehar (2018a , b) has analyzed the effects of monetary policy on poverty. The accelerated growth in investment and control over inflation are the twin objectives of a monetary policy while growth in investment is closely related to the creation of employment opportunities. Any policy instrument which affect the inflation or unemployment will also affect the level of poverty, because magnitude of poverty is determined by the level of unemployment and inflation.

In fact, the effectiveness of monetary policy depends on the utilization of domestic credit to private sector in enhancement of economic and business activities. Mehar (2011) has identified several mechanisms that make monetary policy a regressive option to manage the economy. According to this approach, the most important regressive option is the interest rate spread. A higher rate of interest can lead to the cost push inflation if producers use the debt financing to run their production process and inventory holding. The interest on borrowing from commercial banks to manage the working capital requirements can be included in the cost of production which is a source of cost push inflation ( Mehar, 2018a , b ). The availability of raw material for some industries depends on crop seasons – like sugar, textile, tobacco and food. But, their sales activities are spread over the year. Such industries prefer to adopt working capital financing from banking sector. This situation can lead a higher rate of inflation if interest rate increases. The peoples in lower income groups will be the net looser, if such products are commonly used.

Monetary policy is also a key determinant of investment. The interest rate for lending from commercial banks and the easy access to credit are the components of monetary policy which determine the magnitude of investment.

The growth in credit to private sector improves the market liquidity, which plays an important role in determination of investment. Some studies have defined the market liquidity as a residual of the change in money supply after deduction of public borrowing and time deposits. This liquidity is generated through individual savings, corporate retained earnings, investable funds in financial institutions and inflow of foreign investment.

Fiscal policy is considered also an option to enhance the business activities. However, fiscal support by the government to private sector can generate fiscal deficit, which may be a cause of growing public debt. Consequently, the gilt-edged securities offered by the government to finance its fiscal deficit can divert the investable funds from private equities to government securities. An attractive interest rate on gilt-edged securities creates a selling pressure in equity market which leads to decline in the value of common stocks issued by the companies in private sector. It implies ineffectiveness of fiscal policy because of crowding out effect. Another important aspect of the excessive use of fiscal policy is the borrowing from commercial banks to finance fiscal deficit. Though, it provides an easy option to banks to lend public money to the government, which is the safest option from the bankers' point of view. Moreover, it provides handsome risk-free rate of return to the banks. Though, it reduces the banks' ability to provide credit to private sector.

The higher tax collection by the government to reduce its fiscal deficit may adversely affect the economic growth. The taxes on commodities (general sales tax, excise and import duties) are a usual way to enhance the tax collection. The higher rate of inflation is a natural outcome of such taxes. A report released by Fiscal Policy Department of IMF ( Gupta, 2014 ) stated that some taxes levied on wealth, especially on immovable property, are also an option for economies seeking more progressive taxation. However, it has been observed that policy makers prefer to indirect taxes. It is observed that international financial institutions including International Monetary Fund (IMF) emphasize in enhancing the tax-to-GDP ratio to finance the fiscal deficit ( Mehar, 2005 ). Surprisingly, the IMF does not pay considerable emphasize on the monetary policy in its recommended demand management measures, though its primary concern is closely related to the monetary system.

2. Theoretical background and review of literature

Before evaluation of the effects of the state's involvement in money, banking and credit policies, it seems important to review the history of theoretical development in political economy of money, banking and credit.

Keynesian's macroeconomics policies are broadly divided into three eras: (1) the era based on Keynes' ideas initiated in the 1940s; (2) the monetarist era, associated with the work of Milton Friedman, after failure of Keynesian's ideology in some cases in 1970s and (3) a combined approach of both Keynesians' and Monetarists' ideologies since late 1990s. The effectiveness and limitations of monetary and fiscal policies have been debated in economic literature. The role of monetary policy in economic growth and development has been widely discussed in economic literature. The determination of interest rate, access to credit financing, size of financial inclusion in the economy, volume of the credit to private sector, effects of monetary policy on inflation and GDP growth and effects of interest rate spread on income distribution are included in those topics which have been debated in academic literature. Some new dimensions of monetary policy have been observed during COVID-19 crisis; one of those is the expansion in soft credit policies by banking sector in different countries. One of the common measures which has been adopted by almost every country during the pandemic crisis is the softness in lending to private sector and use of public money to support the business activities.

The interaction of monetary policy, external borrowing and supply of credit to private sector in the context of COVID-19 pandemic have been examined by World Bank (2020) , IMF (2020a , b) , Durrani et al. (2020) , Smith (2020) , Krugman (2020) , Rogoff (2020) , Case and Deaton (2020) , Mehar (2021) and Nemoto and Morgan (2020) . Mehar (2021) has derived a mathematical model to device a criterion to assess the sustainability of external financing. Now, The Economist (2020b) and University of Cambridge (2020) have indicated the beginning of a new era after COVID-19 pandemic. It was advised ( The Economist, 2020a , c ) that governments should find the right path between stimulus and restraint. According to Krugman (2020) , “There will be a hangover from borrowing but it should not pose any major problems.” Rogoff (2020) mentioned that economic catastrophe due to COVID-19 pandemic is likely to rival or exceed that of any recession in the last 150 years. He suggested that governments should inject heavily into the economy. Shirai (2020) has described that the crisis stimulated many central banks to implement substantial monetary easing along with massive fiscal stimulus measures. The central banks in various countries urged the commercial banks to keep lending because reduction in lending will lead to bankruptcies of different businesses which will come back to hurt the banks.

Another important aspect of monetary policy is the use of financial technology for monetary transactions. Haddad and Hornuf (2019) and Foroohar (2019) have identified the limitations and adverse aspects of the uses of financial technology. The use of financial technology covers a broad area from digital currencies, mobile phone wallets, cryptoassets, online remittances, Internet banking, online brokers, robo-advisors, cryptoasset trading, mobile trading to alternative finances through crowd funding, peer-to-peer lending, online balance sheet lending and supply chain finance. According to Marlene et al. (2019) , “fintech” is an advanced technology to improve and automate delivery and use of financial services to consumers and businesses. Gormez (2019) mentioned that electronic money is not a new concept, and technology can enhance the way of dealing, but does not change the fundamental nature. He claims that central banks that have perfectly addressed all the fundamental glitches of money and financial service provision can issue digital currencies with no reluctance. Mehar (2021) found that higher share of population receiving payments by digital modes and the use of the Internet for payments of bills or to buy something online are significant and robust determinants of trade in services. Stijn et al. (2018) mentioned that fintech may improve the efficiency of financial intermediation and provide a substitute funding source for businesses and consumers. Xu and Xu (2019) have explained how the government of China has regulated peer-to-peer (P2P) lending, third-party payment and cryptoassets. Some important aspects of the relations between money, income and payment system have been analyzed by Polak (1957) .

3. Policy intervention for economic growth and development

The philosophy of capitalism supports the assumption of trickle down transfer of resources from top to bottom level. This assumption has justified facilitation to private sector to ensure the continuity of business activities during COVID-19 pandemic. But, it is another reality that the pandemic has affected the different types of businesses in different ways as an increase of more than US$25bn was observed in the worth of top 100 companies ( Mehar, 2021 ). The Financial Times (2020) has classified the pharmaceutical, cloud computing, e-commerce and gaming as winning sectors. Some analysts have expected that the greatest wealth transfer in history will take place over the next three years. Even during the Great Depression, when one-third of Americans were financially devastated, more millionaires were created at that point in time than at any other time in American history ( Gunderson, 2020 ).

Since the financial crisis of 2008, the debate on the state's involvement in banking has become an important topic in political economy and global financial architecture. The debate has gained momentum after COVID-19 crisis when governments have intervened in the lending from commercial banks and the quantitative easing (QE) in monetary policy was adopted by majority of the central banks. To facilitate the private sector, governments have compromised on their tax revenue targets and spending on infrastructure development, while growing deficits have accelerated the rapid expansion in debt financing. The government intervention to protect the private businesses has damaged the targets of sustainable development goals (SDGs) and investment in environmental, social and governance (ESG) projects. While spending on ESG- and SDGs-related projects can play a critical role in eradication of poverty and reducing the income inequalities, the global financial crisis spurred a widespread movement to rethink excess capitalism and overemphasis on profits ( Nemoto and Morgan, 2020 ).

The state's involvement in private businesses was always an important debate in political economy. This debate became more important after fiscal and monetary interventions by several governments in developed and developing countries to manage the effects of COVID-19. The governments all over the world have intervened in private business activities through tax exemptions, subsidies, QE in monetary policies, lowering interest rates, decline in cash reserve ratios and enhancing credit to private sector. However, some analysts think that involvement of state to support some businesses and bail out packages to some industries facilitates the transfer of wealth to some businesses ( Gunderson, 2020 ). The involvement of government is nothing more than the creating a way for utilization of money of some peoples for the benefits or protection of other peoples. Though, utilization of this money for the protection of other peoples may be more beneficial ultimately for the depositors. The legitimacy of government's action to influence the use of depositors' money for protection and promotion of other businesses is transformed through monetary policy. What should be the criterion to determine the role of government in using the public money in commercial banks for protection and promotion of other businesses? Obviously, the intervention by monetary policy will be justified if accelerated credit to private sector promotes the creation of new business entities and trade activities.

What should be the criterion to determine the limitation of state in using the public money in commercial banks to finance the development expenditures and protect the market economy? The “Anglo-Saxon Capitalism” and “German Neoliberalism” provides different responses. The Anglo-Saxon Capitalism which is the representative of Adam Smith's classical economics is practiced in the United Kingdom, the USA, Canada, New Zealand, Australia and Ireland, favors the low level of regulations, low taxes, provision of few essential services by public sector, strong private property rights, contract enforcement and overall ease of doing business and low barriers to free trade. In its present shape it is based on the Chicago School of Economics. The neoclassical economic liberalism in American and British economies is its one of the extreme versions. The underlying assumption of this version is that the inherent selfishness of individuals is transferred by the self-regulating market into general economic well-being. In neoclassical economic liberalism, competitive market should function as equilibrating mechanisms, which deliver both economic welfare and distributive justice. An important point of the economic liberalism is that government should regulate economic activity, but the state should not get involved as economic actor.

The “Ordoliberalism” or “German Neoliberalism” emphasizes the need for the state to ensure that the free market produces results close to its theoretical benefits. Ordoliberals suggest a strong legal system and suitable regulatory framework to ensure that market functions effectively. According to this version, unequal powers of the stakeholders can eliminate the competition in market. The cartels and monopolies can abolish the advantages of free market. So government interference is required to maintain market freedom. It implies that the freedom of markets from government intervention (laissez-faire) is different from the freedom of individuals to compete in markets (liberalism). According to Ordoliberals the main enemy of free society is monopolies instead of the state. So, they oppose creation of monopolies through protectionism, subsidies or cartels. The difference between “Neoliberalism” and “Ordoliberalism” is also described as the difference between a liberal market economy and a coordinated market economy.

Various justifications and perceptions of state intervention in the economy lead to policy differences and then these policies influence the relationship between the public and private sectors. The process and instruments of monetary and fiscal policies including tax rates, tax-to-GDP ratio, public sector development expenditures, subsidies and intervention of government in determination of interest rates, exchange rates and segmentation of the credit to private sector determine the patterns of economic growth and investment. However, a global inclination to “Neoclassical Liberalism” is reflected in the governments' policies in post-COVID-19 world. To manage the rate of interest, expansion in credit to private sector, protectionism, subsidies and participation of state in infrastructure development are the ingredients of “Neoclassical Liberalism”.

Now, the global ranking of countries in their economic growth and development will be changed, depending on the growth and survival of the businesses in post-pandemic environment. The sustainability of existing businesses and the adoption of the required procedures in the new scenario require the survival and continuity of business activities which are closely related with the provision of financing to maintain liquidity and working capital requirements ( Mehar, 2022 ). In this scenario, the involvement of state to facilitate some businesses and bail out packages to some industries may be considered a part to reshuffle the rankings of earnings and wealth. The important question is the net effect of state's involvement on various kinds of businesses and groups in the society. Some analysts consider that the involvement of government is nothing more than creating a way for utilization of money of some peoples for the benefits or protection of other peoples. The peoples' money may be in the form of taxes or their deposits in banks and nonbanks financial institutions. However, it is quite possible that utilization of this money by the government for the protection of other people may be more beneficial ultimately for the depositors and tax payers. The legitimacy of government to utilize those money and its broader consequences is the primary question in this discussion.

Based on the above-mentioned discussion, we established a hypothesis that monetary intervention affects the economic growth and development positively. In this way, we examined the theory that growth in money supply provides an effective strategy for economic growth. The economic growth has been taken in term of GDP growth while economic development is indicated by investment in infrastructure through public-private partnership (PPP). So, this study tests the effectiveness of state's involvement in monetary, banking and credit policies for economic growth and development. The magnitudes of financial inclusions, real interest rate and credit to private sector from banks and other financial institutions have been considered as indicators of monetary policy. The role of state intervention in monetary policy will be justified if effectiveness of these policy devices is accepted. The effectiveness of these policy devices has been tested through empirical evidences in this study. The next section of this paper depicts the economic positioning and investment financing in Central Asia Regional Economic Cooperation (CAREC) and Economic Cooperation Organization (ECO) member countries. The theories regarding the justification and limitation of state's intervention in economic policies have been briefly discussed in this section. Section 5 establishes the models and methodology for empirical testing. Section 6 explains the empirical finding and statistical evidences, while conclusions and some policy implications have been described in section 7 .

4. Leverage financing and monetary policy in CAREC and ECO member countries

The study focuses specially on the member countries of CAREC and ECO. Historically, these countries have experience in using state's intervention in monetary policies for economic growth and development. This study provides also a comparison of these countries with the rest of the world. Further, examining the effectiveness of monetary policy in post-Soviet regime can assess the success of classical economic tools in these countries. So, it can add some new knowledge in the existing literature of economic policies in Central Asian countries.

The patterns of economic growth, investment in infrastructure on PPP basis, external debts and monetary policy indicators have been shown in Tables 1–3 . An objective of these tables is to show the trends of economic and monetary policy indicators before the COVID-19 crisis. A comparison of monetary policies and debt financing reveals the limitations of monetary and credit policies in CAREC and ECO member countries. A bird's eye view of GDP growth, investment in infrastructure on PPP basis, inflow of foreign investment, outstanding debts and monetary policy indicators shows a big variation in the monetary and credit policies in these countries.

These patterns show the diversification in monetary and credit policies among the countries in the region. Another notable point is the lower magnitude of the “credit to private sector as percentage of GDP” in these countries (except China). These countries are far behind in provision of the “domestic credit to private sector” as compared to the world's average (even far behind as compared to middle income countries). The share of short-term borrowing in total external borrowing is higher in China and Iran but other countries heavily rely on long-term debts.

Though, there is a large variation in GDP growth rates among the CAREC and ECO member countries, their rates of growth are higher than world average (except Iran and Turkey). Investment in infrastructure on PPP basis is still a weak area in CAREC member countries except China, while in Western world [including USA, Canada and European Union (EU)] it is completely a private sector activity.

A rapid growth in external debt has been shown in Table 2 ; it is envisaged that large part of external debts of Azerbaijan and Pakistan belong to their public sectors. The most important observation related to the monetary policy is the lower credit to private sector in CAREC member countries (except China). It is lowest in Afghanistan, Pakistan and Tajikistan. The credit to private sector as percentage of GDP in 2019 was 3.2 in Afghanistan, 11.6 in Tajikistan and 18.1 in Pakistan. It was less than 70% in other CAREC member countries, while the world average is 132%. It is an indicator of the inactiveness of banks and credit policy in these economies. The less inclusion of individuals and firms in financial system and the lower magnitude of broad money may be causes of lower magnitude of credit to private sector. Certainly, broad money includes long-term public deposits in commercial banks which is a factor of banks' credit to private sector.

The historical role of state's intervention in monetary policy for economic growth and infrastructure development in CAREC members and some other developing countries has become more justifiable when high income countries have intervened in economic policies to mitigate the severe adverse effects of the spread of COVID-19 pandemic. The monetary and fiscal incentives to private sector and external borrowing by public sector to set off their growing fiscal deficit are those strategies which have been adopted by the governments in developed and developing countries all over the world.

In consequence of such policies, the US budget deficit has expanded to US$4 trillion due to stimulus packages. EU has announced a US$2 trillion plan to fight the impact of coronavirus over the next seven years. Almost half a million companies in Germany have sent their staff on short-term working scheme – known as “Kurzarbeit”. German government has to spend more than EURO 10bn for this scheme. Due to these policies, the IMF (2020a , b , c) has predicted growth in fiscal deficit about 5% points of GDP, on average. Some countries and financial institutions have to rely on external financing; in this case the repayment of unhistorical debts will become a crucial issue. Previously, the largest, fastest and most broad-based increase in debts of developing and emerging countries was observed by Kose et al. (2020) . After the pandemic, the debt will further increase rapidly, which can lead a financial crisis. However, Krugman (2020) , Rogoff (2020) and Mehar (2021) have insisted the debt financing for economic survival. Mehar (2021) has provided a mathematical model to device a criterion to assess the sustainability of external financing.

Other than growing fiscal deficit and external borrowing, the enhancement in credit to private sector from banks and financial institution was a policy instrument which was adopted by the countries all over the world. A rapid increase in financial inclusion was observed all over the world after the pandemic crisis. The banks and financial institutions have introduced user-friendly policies for firms and individuals to use their services. The monetary policy authorities have played a major role in introducing such soft polices. The objective of enhancing financial inclusion and lower rate of interest was the augmentation in credit to private sector. Many central banks have implemented substantial monetary easing. Consequently, growing number of central banks have faced the effective lower bound (or even zero) in their policy rates. The Bank of England, central banks in the Eurozone, Japan, USA, Australia, Canada and New Zealand are included in these banks. The central banks in Brazil, Chile, Columbia, Hungary, Indonesia, the Philippines, Poland, the Republic of Korea, Romania, South Africa and Turkey have also adopted QE ( Shirai, 2020 ). The ease of monetary policy was adopted also by CAREC member countries. The State Bank of Pakistan has reduced the prime rate of interest by more than 5%, which was the largest decline in history of the country.

The expansion in public and private sectors borrowing may lead to a debt crisis. One of the important questions related to this debate is the impact of credit enhancement on economic and development. In the next section, we established a model to assess the impact of credit to private sector on GDP growth and investment in infrastructure. Here, it is important to mention that change and development of infrastructure will be required in the post-COVID-19 scenario. The countries and regions that can manage to change and develop their infrastructure according to the new requirements will be ranked at the higher level in global economic ranking. Despite the required change and development in infrastructure, the majority of governments in present scenario are focusing to meet their recurring expenditures to finance health facilities, subsidies to private businesses and stipends to poor families. The lack of compatible infrastructure in future can lead to further deterioration in economic growth. To attract private sector for investment in infrastructure is one of the options.

Here it is notable that the state involvement in development financing by private sector is known as “PPP”. The public partnership in infrastructure development projects is required despite the private investment. The question regarding the state's involvement in PPP for investment in infrastructure will not be valid if state's participation is limited only for maintaining the law and order situation to protect the infrastructure, and providing guarantees for recovery of user charges, fees or taxes for the use of infrastructure. The government support is required for such long-term heavy investment in infrastructure-related projects.

The credit to private sector may provide financing facilities to infrastructure related projects. Though, monetary policy by the central banks plays an important role in allocation of the credit facilities to different sector and determination of the rate of interest, the banks' ability to lend is determined by other factors also. This study also identifies the determinants of the credit to private sector. It was tested that how real rate of interest and firms and individual inclusion in financial system contribute in augmentation of credit to private sector.

5. Determination of growth, investment and credit to private sector: estimation methodology

In the light of above-mentioned background, a model to determine the role of monetary policy intervention in economic growth and development has been established in this study. The monetary policy intervention in this model has been measured by the magnitude of overall domestic credit to private sector, while tax revenue to GDP ratio reflects the fiscal policy influence. It is supposed that magnitude of the credit to private sector is influenced by qualitative and quantitative measures adopted by the monetary policy authorities. To regulate an indicative (prime) interest rate, setting a mandatory reserve requirement for commercial banks, enhancing financial inclusion of firms and individuals by easing regulatory and procedural requirements and enhancing broad money through attractive schemes by commercial banks to boost their deposits are the discretionary measures which can enhance the size of credit to private sector. It is hypothesized in this study that financial inclusion and broad money influence the size of domestic credit to private sector. We tested the role of domestic credit to private sector, tax-to-GDP ratio, investment in infrastructure on PPP basis, external outstanding debt and foreign direct investment (FDI) in determination of GDP growth. The investment in infrastructure is another indicator of economic development. The determinants of investment in infrastructure have also been explained in the model. How GDP growth and investment in infrastructure will be affected by monetary intervention, it has been tested empirically. The monetary policy intervention will be justified if intervening variables significantly affect the economic growth and development. Figure 1 explains the interaction of investment in infrastructure on PPP basis, domestic credit to private sector, external long-term debt, short-term debt, tax-to-GDP ratio, financial inclusion and FDI. The model is based on four equations, while GDP growth has been taken as targeted variable which can be written in the following linear form: G R O W it = β D C P S it + γ P P P I it + δ X it + μ i + τ t + ε it where “ GROW it ” is annual growth in “Gross Domestic Product (GDP)” for country “ i ” in year “ t ”; “ DCPS it ” and “ PPPI it ” are vectors of variables related to “Domestic Credit to Private Sector” from banks, nonbanking financial institutions and other sources including public-sector enterprises and “Investment in Infrastructure on Public Private Partnership” basis, respectively; “ X it ” is a vector of exogenous control variables; “ µ i ” denotes unobserved time-invariant heterogeneity at the country level; “ τ t ” is a time-fixed effect and “ ε ijt ” is an independent disturbance term.

The theoretical framework employed constitutes the relations between the growth in GDP and the domestic credit to private sector through different channels. It can be described as follows: GRO W it = f ( DCP S it ,   PPP I it ,   FD I it ,   ×   DB T it ) where “ PPPI ” is the investment in infrastructure through PPP. Relating GDP growth to the aforementioned factor, both the estimated direct and indirect effects can be expressed as follows: d G R O W d D C P S = ∂ G R O W ∂ D C P S + ∂ G R O W ∂ P P P I . ∂ T P P P I ∂ D C P S

To estimate the impacts of explanatory factors on GDP growth (GROW), investment in infrastructure on PPP basis (PPPI) and domestic credit to private sector, the following equations have been established: (1) G R O W i t = ∝ i + β 1 D C P S G i t + β 2 P P P I i t + β 3 T X G D P i t + β 4 F D I G D P i t + β 5 X D B T i t + β 6 S T D B T i t + β 7 H I G H i + β 8 C A R E C i + ε i t (2) P P P I i t = ∝ i + β 1 D C P S G i t + β 2 F D I N E T i t + β 3 D B T P B L i t + β 4 S T D B T i t + β 5 H I G H i + β 6 C A R E C i + ε i t (3) D C P S i t = ∝ i + β 1 B M O N E Y i t + β 2 B N K B R W R i t + β 3 B N K F R I N V i t + β 4 I N T R E A L i t + β 5 D S V N G i t + β 6 T R D i t + β 7 W E A L T H i + β 8 R E C E S S I O N t + ε i t (4) B C P S i t = ∝ i + β 1 B M O N E Y i t + β 2 B N K B R W R i t + β 3 B N K F R I N V i t + β 4 I N T R E A L i t + β 5 D S V N G i t + β 6 T R D i t + β 7 W E A L T H i + β 8 R E C E S S I O N t + ε i t

In the first equation, it is hypothesized that growth in GDP (GROW) depends on the size of domestic credit to private sector as percentage of GDP (DCPS), tax-to-GDP ratio (TXGDP), inflow of FDI as percentage of GDP (FDIGDP), external debt (XDBT), short-term debt (STDBT) and investment in infrastructure projects on PPP (PPPI) basis. The tax-to-GDP ratio can affect the growth of GDP negatively. The domestic credit to private sector (DCPS) is a monetary policy indicator which reflects the availability of investable funds and liquid resources to the private sector. We have also introduced two dummy variables in these equations. The high income economies including USA, Canada, Japan, Russian Federation, China, Australia, New Zealand and countries in EU are included in the high income group (HIGH). The dummy variable for this category can capture the experiences of these economies in economic governance. A dummy variable which reflects the situation of PPP in member countries of the CAREC and ECO has also been introduced in the model (CAREC). The CAREC member countries have a historical background where private-sector participation in infrastructure projects was not common. Majority of countries in this set have been used to heavy dependency on public-sector funding to develop the physical infrastructure. The private sector investment for infrastructure development was not a popular way of financing in these countries.

The second equation in the model tests the impacts of domestic credit to private sector (DCPS), external debt to public sector (DBTPBL), net FDI (FDINET) and short-term debt (STDBT) on the investment in infrastructure on PPP (PPPI) basis. The dummy variable to capture the special economic background of CAREC member countries has also been incorporated in this equation. The “CAREC” is a dummy variable which is equal to “1” for those 13 countries which are members of the CAREC or the ECO.

Third and fourth equations determine the causal factors of overall domestic credit to private sector (DCPS) and domestic credit to private sector by banks (BCPS) as percentage of GDP. In these two equations we tested the impacts of broad money (BMONEY) and financial inclusion on the magnitude of domestic credit to private sector (DCPS and BCPS). The financial inclusion was measured by two variables: number of banks' borrowers for per 1,000 adults in a country (BNKBRWR) and the firm getting loans from financial institutions for investment as percentage of total firms (BNKFRINV). We have also tested the impact of the real interest rate (INTREAL) and aggregate domestic savings (DSVNG) on the size of domestic credit. Besides these explanatory variables, we introduced a dummy variable to capture the impact of aggregate national wealth in a country on the domestic credit. Aggregate national wealth is the total sum of the value of a nation's assets minus its liabilities. It refers to the total value of net wealth possessed by the citizens of a nation at a set point in time, while wealth is defined as the value of financial assets plus real assets (principally housing) owned by households, minus their debts ( Credit Suisse Research Institute, 2019 ). Seven countries (the USA, the United Kingdom, Japan, Italy, France, Germany and China) have been defined as wealthy countries. These countries cover more than 70% of global wealth in 2019. According to our selection criterion, a country is defined as wealthy country if its aggregate wealth is greater than US$10 trillion in 2019 and it is included in the list of top 15 wealthy countries for last ten years consecutively. The above-mentioned seven countries fulfill this criterion.

To test the impact of “German Neoliberalism (Ordoliberalism)” on investment in infrastructure based on PPP and GDP growth, a dummy variable (GERMANY) has been included in the model, which is equal to “1” for Germany and “0” for other countries. The other control variables are recession (RECESSION) which is equal to “1” for 2008 and 2009 and “0” otherwise. Aggregate trade as percentage of GDP (TRD) and gross domestic saving as percentage of GDP (DSVNG) are other control variables.

We have included various types of financing in these equations: external outstanding debt (XDBT), external public sector debt (DBTPBL), short-term debt (STDBT) and domestic credit to private sector (DCPS). Some specific characteristics and implications are attached with every type of loan. The short-term debt (STDBT) and domestic credit to private sector (DCPS) may be used as proxy of the availability of funds for working capital. We are interested to quantify their net effects.

We applied data of 186 countries for 18 years (from 2001 to 2018) which makes total observations of 1,674. This sample provide us an unbalanced panel data. This data allows us to apply panel least square (PLS) to estimate the parameters. Tables 4 and 5 depict the descriptive statistics and summarize the changes in the trends of these variables. To test the authenticity of the model, the relevant statistics have been shown in Tables 6–9 . We applied PLS techniques to estimate the effects of explanatory variables. However, data for some countries could not be included in the model because of unavailability of data on some indicators which are included in the analysis. Data for this analysis was extracted from the World Development Indicators' Data Bank ( World Bank, 2020 ). However, data on national wealth was extracted from Credit Suisse Research Institute (2019) .

6. Results and empirical findings

The results of regression analysis have been presented in Tables 6–9 . The robustness in estimated parameters have been checked by using the alternatives options, where some falsification tests have also been conducted. For this purpose some control variables have been included in the regression analysis. These results quantify the impacts of explanatory variables. The results indicate the significance of parameters and overall goodness of fit in the equations. However, some results are shocking and against the common intuitive.

It is concluded that GDP growth is significantly improved by the investment in infrastructure (PPPI), foreign direct investment (FDIGDP) and short-term debt (STDBT). However, tax-to-GDP ratio and external outstanding debt affect GDP growth negatively. The reasons are obvious; the higher tax revenues discourage the business activities while external outstanding debt emphasizes repayments of debts and interest. The interest and repayment of debts can affect the availability of funds for investment in a country. The results validate the previous findings and monetary theories in economic literature ( Baily and Okun, 1965 ; Tobin, 1969 ; Glichrist and Leahy, 2002 ). However, the negative impact of credit to private sector on GDP growth is shocking.

Two dummy variables to represent high income countries (HIGH) and the member countries of CAREC have been included in the first equation to explain GDP growth. The regression analysis shows that growth in CAREC member countries is relatively higher than rest of the world.

The investment in infrastructure based on PPP (PPPI) is significantly improved by domestic credit to private sector (DCPS), external outstanding debt (XDBT) and external public sector debt (DBTPBL). In determination of the investment in infrastructure, it is noted that impact of short-term debt (STDBT) is positively associated with debt to public sector (DBTPBL) but it is negatively associated with outstanding external debt. The domestic credit to private sector can improve the private investment in infrastructure which has been shown in the results of equation: 2 ( Table 7 ).

“German Neoliberalism (Ordoliberalism)” has not been classified as a significant factor of investment in infrastructure based on PPP, while its impact on GDP growth is also weakly significant. Moreover, the high income countries are negatively associated with the PPP model ( Table 7 ) which reflects the fact that infrastructure development in high income countries belong totally to private sector in those countries, where there is no need to implement a “public private partnership model”.

Broad money (BMONEY), number of banks' borrowers and number of firms using banks to finance investment are the indicators of inclusion of firms and individual in financial system. Their inclusion in financial system enhances the size of domestic credit. To reduce indicative (prime) rate of interest during a recessionary period is a common practice by monetary authorities all over the world. However, this study does not confirm the significant impact of the real rate of interest (INTREAL) and recessionary period (RECESSION) on the size of credit to private sector. Similar impacts have been found by Gormez (2019) and Stijn et al. (2018) .

It was hypothesized that financial inclusion plays an important role in determination of the size of domestic credit to private sector. The number of firms getting loans from banks and number of borrowers have been taken as indicator of financial inclusion. The significant and robust effects of these variables suggest that lending to private sector should not be concentrated; its diversification among the large number of borrowers enhances the size of credit to private sector. It confirms the findings by Gormez (2019) .

The factors of credit to private sector have been tested twice: Table 8 shows the impacts of factors on credit to private sector from all sources including banks, nonbank finance companies, private lenders and public sector organizations. Table 9 shows the impacts of causal factors on credit to private sector by banks only. Both equations show the similar results though magnitudes of parameters are different.

The dummy variable to indicate the aggregate wealth status of a country (WEALTH) is equal to “1” if a country's wealth is more than US$10 trillion in 2019 and country is included in top 15 wealthy countries consecutively for the last ten years – wealth of a country is defined as a summation of the financial and physical assets owned by the peoples. Its significant positive association with the credit to private sector describes that financial and physical assets owned by the peoples of a country improve the ability to provide credit to private sector.

The more important evidence is the negative impact of the expansion in domestic credit on GDP growth. But, simultaneous inferences indicates that investment in infrastructure development is significantly supported by domestic credit and long-term external debt by public-sector enterprises. The negative impacts of the credit to private sector and external debt on GDP growth can be converted into net positive effects through positive contribution of these explanatory variables in infrastructure investment. These results are consistent with Mehar (2001) .

7. Policy implications and limitations

The results of this study provide some very important and interesting policy implications. The primary objective of this research is to determine the effectiveness of growth in credit to private sector for economic development. The factors of growth in credit have also been identified. However, this study does not cover the policy shocks and short-term measures to manage the impacts of COVID-19 or other shocks.

The most important conclusion belongs to the role of domestic credit to private sector, which shows a significant negative and robust impact on GDP growth which seems surprising. However, the role of domestic credit in determination of investment in infrastructure is significantly positive and robust in all scenarios. It reveals that domestic credit to private sector is not transformed into GDP growth instantaneously; it improves investment in infrastructure which is a positive significant and robust determinant of GDP growth. The enhancement of domestic credit to private sector may create inflation in short term which is factor of lower GDP growth (in real term). However, the positive impact of credit to private sector on investment in infrastructure ensures the growth of GDP. The policy makers should be ensured and establish a mechanism that external and domestic debts must be invested in required infrastructure and productive assets. Otherwise, it will affect the growth negatively.

The growth of economy is directly linked to the investment in infrastructure, while growth in domestic credit can play a significant role in the enhancement of investment in infrastructure. To create a fiscal space for investment by public sector in developing projects is not a recommendable policy. It will lead to higher tax collection. The crowding out effect of public expenditures for development purposes will make government interference ineffective. Such efforts increase “tax-to-GDP ratio” which negatively affects the economic growth. It has been noted in this study that higher tax-to-GDP ratio affects GDP growth negatively.

The government intervention in banking to enhance the domestic credit during the recession has not been found significant. The size of credit to private sector is not enhanced during the recessionary periods; it is shifted from one to another category of borrowers based on the prioritization set by regulatory institutions. Even the real rate of interest is not a significant determinant of domestic credit. The most important monetary policy instrument is the enhancement in the number of borrowers: firms and individuals. The number of borrowers reflects the inclusion of firms and individuals in the financial system. The credit facilities should not be concentrated. The diversification of borrowers will lead to credit enhancement. It implies that banks should not play a role in creating wealth concentration or monopolies.

FDI affect GDP growth positively but its effect on investment based on public private partnership is negative. In fact, it substitutes the domestic private investment in infrastructure, however, its positive contribution in economic growth is confirmed.

Determinants of GDP growth

Growth and investment in CAREC and ECO member countries