The paper 'How Monetary Policy Rules Influences Economic Crises' is a perfect example of a Macro and Microeconomics Case Study. Monetary policy rules are those rules that guide central banks on how to adjust the nominal interest rate to influence the level of output, inflation, and other macroeconomic conditions. On the other hand, financial crises are associated with business cycles. They are a culmination of a period of economic growth that is usually followed by a downturn. During financial crises economic activities contacts as witnessed by reducing business activities.
The aftermath of major world economic crises made economists and central banks acknowledge that the complexity of an economy is more important than earlier fathomed. In this regard, their ability to solve economic problems to avert economic shocks seemed unachievable. This lead to a situation where many economists seemed not to understand their economies in a way monetary policy rules could be applied effectively to prevent economic shocks and main stability. Nevertheless, the sense of misapprehension that resulted went contrary to the confidence people had on their ability to measure and control their economies.
In this vein, those who viewed macro economies as too complex confirmed the imperfect understanding of its functioning. However, the recent economic crises reaffirmed the extent to which central banks can stabilize the economy with precision. In this view, economic crises doubled the efforts to enhance the robustness of macroeconomic policy rules. The central bank is charged with the responsibility of maintaining stable and low inflation rates. This should be in line with the definition of stable prices that averts a major economic crisis. This study seeks to explore the impact of crises on monetary policy rules. There are various models that link monetary policy to financial crises.
These models indicate that external shocks may lead to unfavorable changes in foreign exchange rates resulting in loss of reserves. However, if such unfavorable changes remain uncontrolled, it could lead to the credit crunch and financial crises. Smets and Wouters (2003) argue that weak monetary policy rules only serve to weaken financial institutions particularly when a significant portion of their liabilities are denominated in foreign currency.
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