Monetary Policies and the Control of Levels of Interest Rates

Running head: MONETARY POLICES 1
Monetary Policies and the Control of Levels of Interest Rates
Institutional Affiliation
Monetary Policies and the Control of Levels of Interest Rates
Monetary policies are the actions of a country’s central bank or any other regulatory
committee that is mandated by a state to control the quantity and growth rates of the money
supply. Such policies are maintained through a wide range of actions such as the modification of
the interest rates, peddling of federal bonds and restructuring the number of bank reserves
(Overview of the Federal Reserve System,” n.d.). The policies can be either expansionary or
contractionary. Expansionary monetary policies are aimed at creating employment opportunities
and improving borrowing rates and consumer spending with the aim of stimulating the economic
growth. On the other hand, contractionary monetary policies slows down the money supply rates
to control inflation. This policy reverses the financial gains realized by expansionary fiscal
policies. As demonstrated in the actions of People’s Bank of China and the Federal Reserve
Bank of the USA, central banks can use discount rates, open market operations, and reserve
requirements to achieve the required monetary policy.
Agencies Responsible for Monetary Policy in the USA and China
The US Federal Reserve Bank (Fed) is mandated to increase the employment rates and
address inflation as well as ensuring the interest rates are maintained low. Fed regulates financial
institutions and plays the role of a last resort financial lender to the banks while providing
liquidity to the banks with liquidity to save them from financial shocks in the industry. The Fed
aims at keeping the inflation at between 2 and 3 % and employment rates at 5% (“Overview of
the Federal Reserve System,” n.d.). Fed’s Open Market Committee (FOMC) buys and sells US
resources in open market operations to increase money supply with the aim of lowering the
interest rates, setting the rates that banks with healthy credit ratings pay on overnight loans, and
establishing the reserve requirement. The FOMC is comprised of the Fed’s Board of Governors,
New York Fed’s President, and four of the rest of 11 presidents of regional reserve banks, who
serve on a rotational basis.
In China, People's Bank of China (PBOC) is mandated to formulate the monetary policy,
and it is equivalent to the USA’s Fed. It controls and supervises the domestic financial sector and
the banking system. PBOC represents China in global financial organizations such as the
International Monetary fund (IMF) the World Bank, and The Asian Development Bank (ADB).
The functions of the PBOC’s Monetary Policy Committee include the formation of credit plans,
setting of interest rates, regulation of the financial market, issuance of Renmimbi, control of the
interbank bond market, and management of foreign exchanges. PBOC performs these
responsibilities with the aim of maintaining financial stability and stimulating economic growth.
The committee is composed of the Governor and Deputy Governors of PBOC, vice ministers of
the State Development and Reform Commission and Finance, the President of the China
Association of Banks, the National Bureau of Statistics Commissioner, and chairpersons of
China Banking Regulatory Commission, Securities Regulatory Commission, and Insurance
Regulatory commission (PBOC, n.d.). Other members include the State Administration of
Foreign Exchange’s Administrator and an academic expert.
Instruments Used by the Agencies
Fed Role
Fed uses the open market operations, the discount rates, and reserve requirements tools to
implement monetary policy. While the Fed’s Board of Governors is responsible for the discount
rate and reserve requirements, FOMC is mandated to oversee open market operations, which
directly affect the rates at which the depository institutions lend each other, also known as the
Federal Funds (FF) rates (Thornton, 2004). The FOMC also oversees the operations undertaken
by the Fed in the foreign exchange markets and the currency swap programs in different foreign
central banks.
The Fed has managed the short-term rates since the 1970s through open market
operations (Thornton, 2004). Fed reduces the supply of reserves through a free market sale,
which leads to a reduction of interest rates through the acquisition of securities. This action
affects the Federal Funds (FF) rate and short-term rates. Analysts have questioned the
effectiveness of open market operations in managing the short-term interest rates. Some have
even suggested development of a model driven by private agents to determine the interbank rates
to the levels desired by the Fed and FOMC. This school of though regulates the money market
operations and creates a formidable relationship between the interest rates changes and the
financial processes initiated by financial institutions. Since the open market policy affects the
availability of reserves, FF rates are affected in the process. The long-term rates are subject to
markets’ dependence on FF rate (Thornton, 2004). With this direct impact on the reserves, it can
be deduced that Fed through FOMC controls the FF rates. The ability of the FOMC to influence
the short-term rates is a challenge since the Fed open market operations are relative to the market
rates. Due to this reason, the required open markets to absorb the economic shocks may be
bigger than it is practical, since the banks depend on the reserves to meet their daily needs. To
address such problems, FOMC must allow Fed to regulate the fund's rate in times of shocks that
lead to considerable changes in short-term rates.
The Role of PBOC
In the last three decades, China has made remarkable progress towards achieving market-
oriented, interest rate systems. Currently, the interest rates can be grouped into central bank
operations, banking products, bond markets, and other financial markets (He, Wang, & Yu,
2015). PBOC controls the interest rates in the banking sector. Bank rates are at low levels to
extract subsidies from the households to the corporate sector, primarily the State Owned
Enterprises (SOEs). However, PBOC acknowledges that the low interest rates require the
primary stakeholders to exercise self-discipline in their pricing strategies (He et al., 2015). At the
national level, when the bond markets are underdeveloped, PBOC controls the interest rates
through direct control rates.
Regardless of the policies, PBOC relies on the quantity-based instruments to achieve its
interest rates control goals. Tools such as aggregate credit quotas and reserve requirement ratios
are used to constrain credit supply (He et al., 2015). The bank also uses the lending rate floor to
curb the loans demand. This analysis is a clear indication that the changes precipitated by the
price regulations can only be addressed by aggregate credit quotas or reserve requirement ratios
(He et al., 2015). PBOC must maintain a benchmark or policy interest at equilibrium levels
In most cases, the PBOC relies on the reserve requirement rate to effect control interest
rates. The reserve requirement rate is a top-down monetary policy instrument that requires banks
to keep a proportion of their deposits in the reserve. PBOC varies the rate based on the three
types of financial institutions in the country: small and medium banks are expected to comply
with 17.4%, large banks at 19.5%, and credit cooperatives at 16% (Gehringer, 2015). As such,
due to the important role played by the banks in the Chinese economy, the effectiveness of this
instrument in influencing the money supplied to the economy has increased its use by the PBOC
(Gehringer, 2015).
Effects of FF Rate Change on Money Market Rates and Yield Curve
FF rates are influential in the money market, since they are the overnight market cost of
credit in the USA. The Fed policy shapes up the FF market and the market growth (Goodfriend
& Whelpley, 1998). The FF rates are short-term borrowings of urgently available money. The FF
rates can only be accessed by financial institutions recognized under the Monetary Control Act
of 1980 to hold their reserves with Fed. FF rate is also different from other borrowings because it
is exempt from both reserve requirements and interest rate ceilings.
The Fed has a dominant influence on the determination of the FF rates to which other
money market rates are anchored. Participants in money market determine the rates according to
the existing and future FF rates. Banks raise funds through overnight borrowing (Goodfriend &
Whelpley, 1998). Any corporation considering buying a treasury bill can acquire its resources
over the term of the bill, which is mostly tied to the FF rate. The choice depends on the
alternative that gives highest returns. Such considerations by market participants make the
existing Fed policy towards the FF rates a critical determinant of the money market rates.
However, the money markets are also subject to Fed’s monetary policy and economy-wide
variables, such as unemployment and inflation ( “Overview of the Federal Reserve System,”
n.d.). With the movements of the FF rates, which are subject to movements in short-term interest
rates, FF rates are likely to change the yield curve.
Impacts of PBOC’s Short-Term rate on Money Market and Yield Curve
In the last decade, studies have prioritized the monetary policy strategies in China. Areas
of focus include the short-term rates and long-term bond rates (Garcia-Herrero, Girardin, &
Lunven, 2011). Bond rates are dependent on the future systems, and therefore, the effectiveness
of monetary policy depends on the deformations of the yield curve, which is an indication of the
direction of the future fiscal policies.
Existing literature shows that monetary policies have a significant impact on the yield
curve (Garcia-Herrero et al., 2011). The slope of the curve is dependent on the nature of the
future inflation. An inverted yield curve is an indication of a reducing rate of interest in future.
Contractionary policy shocks are also known to trigger positive responses in the short-term
interest rates.
Both Fed and PBOC play critical roles in controlling the interest rates to promote the
economic growth of the USA and China respectively. These institutions have instituted policies
that have improved the economic growth by fostering growth, controlling the interest rates, and
formulating fiscal policies. These institutions will continue to be essential regulators of monetary
policy in their countries with the view of creating sustainable economies. There is the need for
the governments to continue supporting these institutions in efforts to have effective monetary
policies through can use discount rates, open market operations, and reserve requirements.
Garcia-Herrero, A., Girardin, E., & Lunven, S. (2011, Dec.). Monetary policy transmission on
the yield curve in China during the financial crisis. Retrieved from http://www.edge-
Gehringer, A. (2015, Jan. 7). Monetary policy made in China. Retrieved from http://www.fvs-
Goodfriend, M., & Whelpley, W. (1998). Chapter 2: Federal Funds. Retrieved from
He, D., Wang, H., & Yu, X. (2015). Interest rate determination in China: Past, present, and
future. International Journal of Central Banking, 11(4), 255-277.
Overview of the Federal Reserve System. (n.d.). Retrieved from
The People’s Bank of China [PBOC]. (n.d.). Monetary Policy Committee. Retrieved from
Thornton, D. L. (2004). The Fed and short-term rates: Is it open market operations, open mouth
operations or interest rate smoothing? Journal of Banking & Finance, 28(3), 475-498.

Place new order. It's free, fast and safe

550 words

Our customers say

Customer Avatar
Jeff Curtis
USA, Student

"I'm fully satisfied with the essay I've just received. When I read it, I felt like it was exactly what I wanted to say, but couldn’t find the necessary words. Thank you!"

Customer Avatar
Ian McGregor
UK, Student

"I don’t know what I would do without your assistance! With your help, I met my deadline just in time and the work was very professional. I will be back in several days with another assignment!"

Customer Avatar
Shannon Williams
Canada, Student

"It was the perfect experience! I enjoyed working with my writer, he delivered my work on time and followed all the guidelines about the referencing and contents."

  • 5-paragraph Essay
  • Admission Essay
  • Annotated Bibliography
  • Argumentative Essay
  • Article Review
  • Assignment
  • Biography
  • Book/Movie Review
  • Business Plan
  • Case Study
  • Cause and Effect Essay
  • Classification Essay
  • Comparison Essay
  • Coursework
  • Creative Writing
  • Critical Thinking/Review
  • Deductive Essay
  • Definition Essay
  • Essay (Any Type)
  • Exploratory Essay
  • Expository Essay
  • Informal Essay
  • Literature Essay
  • Multiple Choice Question
  • Narrative Essay
  • Personal Essay
  • Persuasive Essay
  • Powerpoint Presentation
  • Reflective Writing
  • Research Essay
  • Response Essay
  • Scholarship Essay
  • Term Paper
We use cookies to provide you with the best possible experience. By using this website you are accepting the use of cookies mentioned in our Privacy Policy.