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Monetary policy responses to financial crises vary depending on the country, ideology of policy makers, unique circumstances, and goals. Lowering interest rates can stimulate the economy, while raising them can cause contraction.
The relationship between monetary policy and financial crisis is related to how monetary policies are applied during a period of financial crisis. Applying a monetary policy depends on the country, the ideology of monetary policy makers, the unique circumstances surrounding the crisis, and the goal that financial policy makers are trying to achieve. In other words, there is no single response to a financial crisis through the application of monetary policy as different countries may apply different monetary policies in a similar financial crisis.
The first consideration when looking at the link between monetary policy and financial crisis is the identification of the exact type of financial crisis the country under consideration is facing. Assuming that the financial crisis takes the form of an economic crisis or a recession, the country could apply monetary policies aimed at kick-starting the economy from the crisis it is facing. When a country is in a recession, the general response of monetary policy makers, usually the country’s central bank, will be to cut interest rates in the hope that this will ease the pressure on consumers by causing a recession in the economy.
For example, lowering interest rates will make it easier for people to get credit and other forms of financing for various purposes. Easier access to money could encourage people to spend more, leading to higher demand for finished products and other consumables. In this case, companies will be encouraged to produce more and the increase in financial assets will serve as a much-needed jolt to the economy. This shows a link between monetary policy and the financial crisis. When this type of monetary policy is applied, it is described in economics as an effort to expand the economy.
In the same way that monetary policy can be used to cause an expansion in the economy, it can also be applied with the opposite effect. This means that monetary policy can be used to make the economy contract. This is another connection between monetary policy and financial crisis, because this method can also be used as a solution to a financial crisis. When the intent of monetary policy makers is to cause a contraction in the economy, they can raise interest rates in order to achieve the desired result in resolving the financial crisis.
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