The strategies a nation’s central bank employs concerning the amount of funds circulating in the economy and the worth of that money is called monetary policy. The ultimate motive of a monetary policy is achieving long-term economic growth. However, central banks might have different stated goals towards this end. The Federal Reserve’s monetary policy in the US, goals are to upgrade maximum employment, moderate long-term interest rates and stable prices.
Moreover, the Bank of Canada aims to maintain inflation near 2%. Depending on the view that low and stable inflation is a better contribution that monetary policy should make to a well-functioning and productive economy.
Investors must hold a good understanding of monetary policy and then invest, as it might have a significant impact on investment portfolios and net worth.
- The central banks enact monetary policies to keep inflation, economic growth, And unemployment Positive and stable.
- Central banks increase interest rates and take other contractionary measures to slow things down when the economy overheats, which might discourage investing and lower asset prices.
- The central bank reduces rates and adds money and liquidity to the economy during a recession, which stimulates consumption and investment, positively impacting the asset price.
- An Investor can take advantage of Fluctuations in rates or other measures a central bank applies when they understand how a monetary policy influences several asset class prices.
Impact on investments
A monetary policy can be accommodative, neutral, or restrictive. When an economy grows rapidly, and inflation moves significantly higher, the central bank measures to cool the economy and raises short-term interest rates, constituting a restrictive policy. Similarly, the central bank adopts an accommodative policy when the economy is sluggish and lowers short-term interest rates to stimulate growth and get the economy back on track.
Monetary policy impacts investments directly as well as indirectly. The level and direction of interest rates, has a direct impact on investments; however, Through expectations of where inflation is headed it has an indirect effect.
Cash, real estate, currencies, commodities, bonds, share and equities are the primary asset classes across the board that are affected by the monetary policy.
Monetary policy tools
Several tools are present at the disposal of central banks for influencing monetary policy. The Federal Reserve, for example, holds three main policy tools –
- By the Federal Reserve, Open market operation involves purchasing and selling financial instruments.
- The Federal Reserve charges an interest rate, or discount rate for depository institutions on small-period loans.
- Proportion of deposits or the reserve requirements that must be maintained by the banks as reserves.
Accommodation of monetary policy
Performance of a few assets when the monetary policy is loose-
- During the periods of accommodative policy, cash is not king; most of the investors prefer deploying their money anywhere instead of parking it in deposits which provide minimal returns. Savings become less attractive to depositors with low-interest rates.
- When the interest rates are lesser, real estate performs well, as the investors and homeowners take advantage of lesser mortgage rates and snap up the properties.
- Commodities tend to appreciate during periods of accommodative policy for several reasons, and they are quintessential – risky assets.
- During the harder times, the effect on currencies is certain, even though accepting a nation’s currency and an accommodative policy for depreciating against its peers might be logical. If most of the currencies hold lesser interest rates, the impact entirely depends on the expansion of monetary stimulus and the economic outlook for a certain nation.
A significant impact can be phased by every asset class when a monetary policy changes. However, by being aware of the certain nuances of monetary policy, investors place their portfolios for benefiting from boosts, returns, and policy changes.