Introduction
In times of financial crisis, the economy shrinks and everybody becomes risk averse to avoid incurring huge loses given that nobody is sure of what will happen next. Monetary policy makers need to keep the economy moving and this will be done by implementing policies that will stimulate economic growth. Among the problems that the monetary policy makers face in their course of implementing policies, is the fact that they make decisions in a very uncertain environment because they do not have complete information about the interrelationships between the economy and how the dynamics will impact on the economy. In times of financial crisis, expansionary monetary policy is paramount because people need to spend in order to boost economic growth therefore reducing unemployment. Though the central bank may be very willing to stimulate the economy, people need to be involved and it is the confidence of people in the central bank that will help in the success of the policies that will be taken by the central bank.
Causes Uncertainty
Uncertainty about the results of the monetary policy are caused by several f actors which unfortunately are known by the public and which will in the end reduce the probability of success of the monetary policy actions. To begin with, there is limitation about the structure of the economy where the policy makers themselves are not sure of how the economic units will react to any step taken therefore, any move taken by them is a trial to achieve desired results. Additionally, the current state of the economy is always a misery since it changes from time to time and policy makers have to depend on the information collected hitherto which does not exactly depict the picture of the current state of the economy. During times of crisis, the economic state is changing at a higher rate and requires efficient and quick actions but the rate of flow of information is not that fast.
Unfortunately, it is very difficult to have the exact data from all economic units to evaluate how the economy is performing and most of the times what is used is a sample and given how large and complex countries are, samples might not be a true picture. Therefore, policies are taken based on the results of the sample and not on complete information thus, making the policies more of trial and error. Lastly, the uncertainty of the monetary policy is culminated with the lack of information about the expected future events thus, making monetary policy counteractive that proactive.
Ways of Achieving Credibility
In crisis situation, most people tend to believe that it is the failure of the central banks to implement good monetary policies which could cushion the economy thus, leading to the problems. This coupled with the fact that monetary policy decisions are made in conditions of uncertainty, the knowledge which the public has, makes people lose confidence with any actions of the central banks. Therefore, credibility is paramount for effective monetary policy decisions which are essential during crisis.
The first step that can help central banks gain their credibility and build their confidence among the public is ensuring that communication is efficient and improve their transparency because that will go a long way in ensuring accountability. External communication is important in shaping the perceptions of the public and thus, aligning the expectations of the public with the aims of the monetary policy. It should be noted that, it is expectations of the public that drive the economy towards the expected results of the monetary policy as opposed to actual policy implementation.
Additionally, having good governance creates the picture in the public that the central bank always has effective policies and thus, improves confidence of the public in the central bank. If the bank is known to have made decisions which were not effective in the past then its confidence in the public reduces significantly and in that case, a lot needs to be done. Therefore, central banks need to learn from past mistakes and improve in their use of resources and meeting regularly so as to take into consideration the small economic changes that occur from time to time.
During crisis, expenditure is paramount to stimulate the economy because many people avoid spending therefore reducing demand and the central bank can boost demand by reducing the interest rates, to increase the amount of money in the economy. Unfortunately, commercial banks which act as intermediaries are cautious on who they lend money to and tighten their lending conditions therefore, holding money instead of giving it out to the public for spending. This will reduce the confidence of the public since they will not see the money that the central bank will have increased. Central banks therefore need to make some structural reforms to ensure that the cautious attitude of the commercial banks is reduced and the money is passed onto individuals and firms who will then spend it. That way people will be confident that the central bank is really taking positive actions and therefore, investors’ confidence will increase besides increasing future inflation expectations
On top of that, transmission of monetary policy in crisis is difficult due to dysfunctional financial system which prevents proper functioning of any monetary policy chosen. During the 2008 crisis central banks focused on reducing the imperfections in the money market and thus, hastened the transmission process of the monetary policy decisions which led to successful impacts in the real economy. When the monetary policy decisions are effectively transmitted across the economy, individuals and firms become aware of the decisions in good time and their confidence in the central bank increases.
The financial strength of the central bank is also important because the public need to get money that will be spent in the economy. It is therefore important for the central bank to ensure that liquidity is increased especially during times of crisis and this should be communicated to the public as efficiently and as openly as possible. Bailing out of companies which are at the verge of bankruptcy, communicates a lot to the public about the financial stability of the central bank and its readiness to help as it was done in the 2010 crisis when General motors and other companies were bailed out. The central bank can also purchase foreign currency, stocks and government bonds as opposed to short term securities which are easily substitutable for base money.
Conclusion
Monetary policy cannot be a lonely answer to financial crisis and should therefore be implemented along with other steps to ensure its effectiveness. On top of that, credibility of the central bank is vital because it not only ensures that monetary policy decisions are effective in countering financial crisis but also their timely transmission to the real economy.