Effectiveness of the Transmission of Monetary Policies and Lessons Essay

Effectiveness of the Transmission of Monetary Policies and Lessons Learned in 2007 and 2008 Global Financial Crisis - Essay Example It has also resulted in a number of debates as regards the effectiveness of the transmission mechanism of monetary policies. In the past, monetary policy has been associated with a financial stability of an economy. The problem that a majority of countries face is concerned with the effectual transmission mechanism of an effective monetary-policy. A number of lessons can be learned regarding the effectiveness of the transmission mechanism of monetary policy by central banks in the year 2007 and 2008. The lessons would be based on interest rate, inflation, exchange rates, balance sheet, expectations, as well as moral hazards that characterized the market prior, during and after the 2008 global economic-crisis. A Brief State of the 2007 Financial Crisis and Failure of the Monetary Policy Transmission Mechanism Although financial crisis is not a unique occurrence, the financial crisis of 2007 was more global than other economic crises experienced in the past (Mankoff, 2010). It is also regarded as the most impactful relative to other proceeding financial crises. Due to its high level of degree in terms of impact and globalization, a large number of monetary policymakers were compelled to utilize both conventional and unconventional financial policies. A majority of economic analysts as well as financial institutions in the world were surprised by the fast pace at which the subprime crisis in the US led to a world financial crisis (Cecchetti, 2009, p. 53). The global financial crisis led speedily to a world economic crisis. This fast pace left a considerable number of individuals in the business and financial circles with unanswered questions regarding the effectiveness of the transmission mechanism of monetary policy. In particular, the 2007 and 2008 financial crisis questioned the effectiveness of various institutional frameworks (Mankoff, 2010). It also questioned the national and internal monetary instruments in ensuring financial stability at the global level. In relation to Shiller’s (2008) argument, attention has been paid to the role and operation of financial markets, as well as financial institutions. Specifically, questions regarding the effectiveness of financial institutions and markets to price and administer risk have been raised. Analysts observe that there have been inability of private sector to manage risk effectively, and failure of public sector’s supervision of the financial markets (Mankoff, 2010). Interest rate While the financial world changed in the year 2007, the monetary instruments were not updated to handle the change (Swagel, 2009, p.43). The instruments were not transmitted effectively to realize positive impact. Initially, interest rates were traditionally treated as the main financial instrument that would protect an economy against financial difficulties, as well as enhance economic growth. A large number of emerging economies, including India, lowered their interest rates in an anticipation th at both prices and output would respond effectively. However, both output and prices did not respond in respect to the anticipation. An interest rate is majorly used in managing the supply of money in an economy. Interest rate has been observed by many individuals as a key monetary instrument in controlling lending and borrowing between financial institutions and consumers. The borrowing and lending is also executed amongst financial institutions. In the event that there is a high supply of money in an economy, a central bank would opt to raise the level of an interest rate. In this regard, credit availability is likely