Monetary Policy

Monetary Policy

Plan:

• Definition of Monetary Policy
• Objectives
• Types of Monetary Policy
• Instruments
• General (quantitative) methods
• Selective (qualitative) methods
• Conclusion

Definition of Monetary Policy

• Policy affecting quantity of money which determines cost and availability of credit.
• The variation effect the demand & supply of credit in an economy, and the level or nature of economic activities
• Monetary Policy Refers to measures designed to influence the cost and availability of money for the purpose of influencing the work of the economy

Objectives

These are the general objectives which every central bank of a nation tries to attain by employing certain tools (Instruments) of a monetary policy.

• Stability in price level
• Economic development
• Arrangement of full employment
• Stability in exchange rate
• Higher Economic Growth It is the most important objective of a monetary policy. The monetary policy can influence economic growth by controlling real interest rate and its resultant impact(получающийся в результате импульс) on the investment.
• Level of economic growth determines fulfillment of social and economic need of people
• Only way to create job and eradicate(истреблять) poverty
• Faster economic growth is possible if the monetary policy succeeds in maintaining income and price stability
• Higher Rate of Employment
• Monetary policy can be used for achieving full employment. If the monetary policy is expansionary then credit supply can be encouraged. It could help in creating more jobs in different sector of the economy.
• Full employment it is the situation when all resources available in country are mobilized, National Income is maximum
• High employment is desired: Unemployment leads to lost output(производительность)
• Price Stability
• All the economics suffer from inflation and deflation. . Inflation increases price; deflation decreases. It can also be called as Price Instability. Both are harmful to the economy
• The monetary policy having an objective of price stability tries to keep the value of money stable
• Exchange Rate Stability
• Exchange rate is the price of a home currency expressed in terms of any foreign currency. If this exchange rate is very volatile leading to frequent ups and downs in the exchange rate, the international community might lose confidence in our economy. The monetary policy aims at maintaining the relative stability in the exchange rate.

Types of Monetary Policy

• Monetary policy is referred to as either being an expansionary policy, or a contractionary policy
• Expansionary policy increases the total supply of money in the economy(“cheap money policy” )
• Contractionary policy decreases the total money supply(“dear money policy”.)
• When the economy suffers from recession the monetary policy should be an “cheap money policy” but when there is inflationary situation there should be a “dear money policy”. Both affect the velocity of circulation of money
• Inflation => “Dear money policy”
• Business activity expands rapidly
• More cash is released by banks making additions to consumers’ income and outlay
• Aims of the Monetary Policy slow down the rate of expansion of money
• Reduce the volume of liquid assets
• Reduce consumption & investment by means of higher interest rates

• Depression  => “Cheap money policy”
• falling prices, incomes, output & employment
• Low interest rates
• High liquidity preference
• Monetary Policy aims to offset decline in velocity of money
• Bring down structure of interest rates to encourage investment
• Bring down the interest rate
• Increases aggregate demand
• Stimulate lending for investment & consumption purpose

Instruments

The instrument of monetary policy are tools or devise which are used by the monetary authority in order to attain some predetermined objectives. There are two types of instruments of the monetary policy

• Quantitative  Control:

they are so called because they control the quantity of money

• Bank Rate
• Open Market Operations
• Variable Reserve Ratio
• Qualitative Controls:

they are usedto limit the amount of money available for certain specific purposes even though plenty of money may be available for other purposes, i.e. they control the quantity as well as direction of money flow;

• Consumer Credit Control
• Credit Margin Requirements
• Moral Suasion

General (quantitative) methods

• Bank Rate/Discount Rate
• The Bank Rate is a very important technique used in the monetary policy for influencing the volume or the quantity of the credit in a country. The bank rate refers to rate at which the central bank rediscounts bills and prepares of commercial banks or provides advance to commercial banks against approved securities.
• It is the rate of interest the central bank charges its member banks.
• By changing the discount rates, the central bank controls the level of bank reserves and the money supply.
• Method: Discount rate affects bank interest rates
• Open Market Operations
• The open market operation refers to the purchase and/or sale of short term and long term securities by the Central Bank in the open market. This is very effective and popular instrument of the monetary policy.
• Open Market Operations means buying and selling of government bonds or securities by the Central Bank
• Increase Money supply => Central bank purchases securities from open market
• Decrease Money supply => Central Bank sells securities
• Variable Reserve Ratio
• The Commercial Banks have to keep a certain proportion of their total assets in the form of Cash Reserves. This Reserve Ratio is used for the purpose of maintaining liquidity and controlling credit in an economy
• Commercial bank has to keep a certain percentage of his deposits with Central bank
• It control the cash flow in economy
• It keeps changes in monetary policy framed by Central bank of a country
• Banks create credit on the basis of their cash reserves
• The greater the excess reserves, the greater the credit created

Selective (qualitative) methods

• Consumer Credit Control
• This method helps to regulate the terms and conditions for the purchase of durable consumer goods
• Changing minimum down payment
• Changing maturity period of consumer credit
• Changing cost of consumer credit
• Credit Margin Requirements
• By prescribing the Margin requirement the Central Bank sets the limit to the amount of loan extendable
• Central Bank fixes credit amount to be granted
• Credit is rationed by limiting the amount available for each commercial bank
• Moral Suasion
• It implies to pressure exerted by the Central Bank on the banking system without any strict action for compliance of the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods.
• Moral Suasion involves advice, request and persuasion with the commercial banks to co-operate with the Central Bank
• It helps in restraining credit during inflationary periods

Conclusion

• Monetary policy is the management of money supply and interest rates by central banks to influence prices and employment
• Monetary policy works through expansion or contraction of investment and consumption expenditure
• Monetary policy is the process by which the government, Central bank or monetary authority of a country controls:
• The supply of money
• Availability of money
• Cost of money or rate of interest