MONETARY POLICY

Definition:
Monetary Policy refers to the credit control measures adopted by the

central bank of a country. Monetary policy “as policy employing

central bank’s control of the supply of money as an instrument for

achieving achieves of general economic policy.”

OBJECTIVES OF MONETARY POLICY

• The following are the principal objectives of monetary policy:

• Full Employment

• Price Stability

• Economic Growth

• Balance of Payments

• Exchange Rate Stability

• Neutrality of Money

• Equal Income Distribution

1. Full Employment: Full Employment has been ranked among the

foremost objectives of monetary policy. It is an important goal not

only because unemployment leads to wastage of potential output,

but also because of the loss of social standing and self-respect.

2. Price Stability • One of the policy objectives of monetary policy is

to stabilize the price level. • Both economics and favour this policy

because fluctuations in price bring uncertainty and instability to the

economy.

3. Economic Growth – One of the most important objectives of

monetary policy in in recent years has been the rapid economic

growth of an economy. – Economic growth is defined as “the

process where by the real per capita income of a country increases

over a long period of time.”

4. Balance of Payments

Another objectives of monetary policy since the 1950s has been to

maintain equilibrium in the balance of payments.

5. Exchange Rate Stability:

 • Exchange rate is the price of a home currency expressed in terms

of any foreign currency.

• If the 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.

6. Neutrality of Money:

Economist such as Wicksted, Robertson has always considered

money as a passive factor. According to them, money should play

only a role of medium of exchange and not more than that.

Therefore, the monetary policy should regulate the supply of

money.

7. Equal Income Distribution:

Many economists used to justify the role of the fiscal policy is

maintaining economic equality. However in recent years

economists have given the opinion that the monetary policy can
 help and play a supplementary role in attaining an economic

equality.

TYPES OF MONETARY POLICY

Monetary policy design changes as per the goals set for the

monetary policy and the emerging economic scenario. The

monetary policy is characterised as

• Expansionary Monetary Policy

• Contractionary Monetary Policy

. Expansionary Monetary Policy

Expansionary or easy monetary policy aims at encouraging

spending on goods and services by expanding the supply of credit

and money by lowering the policy rates (bank rate or repo rate),

lowering the reserve requirements and purchasing the government

securities from the market.

Contractionary Monetary Policy

• Contractionary or tight monetary policy aims at preventing

inflation by contracting the money supply.

 • Contraction in money supply is achieved by increasing the

policy rates, increasing the reserve requirements and purchasing

the government securities from the market.

INSTRUMENTS OF MONETARY POLICY • Credit control is

an important tool used by Reserve Bank of pakistan, a major

weapon of the monetary policy used to control the demand and

supply of money in the economy.

.
TOOLS / INSTRUMENTS OF MONETARY POLICY
There are two types of instruments such as:

• Quantitative Measures

• Qualitative Measures

QUANTITATIVE MEASURES: • Open Market Operation • Change in

Reserve Requirements • Changes in Reserve Capital • Credit Rationing • Bank

Rate Policy • Changes in Marginal Requirements

OPEN MARKET OPERATION Purchase and sale of eligible securities by

the central bank. At inflation and boom, the central bank sells securities in the

open market and withdraws the surplus money from circulation.

CHANGES IN RESERVE RATIO: Through this policy the central bank

determines that a certain proportion of cash deposit from commercial banks is

 to be deposited with it (central bank) so that the central bank by this way

influences the volume of credit in country.

 Example in Pakistan a total of 5 % cash is to be kept against demand and

time deposits in the central bank.

If the central bank wants to reduce money supply it increases the reserve ratio

requirement.

If the central bank wants to increase money supply it decreases the reserve

ratio requirement.

CREDIT RATIONING

By credit rationing the central bank fixes the credit ceiling allowed for each

and every commercial bank and will not give further credit to them beyond

limit allowed.

 It is the rate at which central bank rediscount the first class bills.

 During the period of inflation central bank raises bank rate.

 During the period of deflation and depression central bank lowers the

bank rate.

CHANGES IN MARGIN REQUIREMENTS:

Marginal requirement is the percentage difference between the value of the

collateral against the loan and the amount of loan given itself to the borrower by

commercial banks Example:

The collateral is 100 and the loan given by the bank is 75. thus by this way we can

say that margin requirement is 25%.

QUALITATIVE MEASURES:

• Direct Action

• Publicity

• Moral Suasion

DIRECTACTION:

•This method of control will only be applied when the previous method has

failed. As, it is now assumed that commercial banks have now become a threat

to the policy, in spite of moral suasion i-e they continue to give loans as usual

and thus the central bank is forced to take direct action against these

commercial banks.

PUBLICITY:

From time to time central bank publishes details concerning commercial

banks. The central bank refers to such measure specially when the inflation

period is getting worse. The reason for central bank doing this is to keep the

public aware of the commercial banks activities so that the people actually

know to what and where their money has gone.

MORAL SUASION
•Moral suasion means persuasion and request. To arrest inflationary situation

central bank persuades and request the commercial banks to refrain from giving

loans for speculative and non-essential purposes. On the other hand, to

counteract deflation central bank persuades the commercial banks to extend

credit for different purposes.

. SIGNIFICANCE OF MONETARY POLICY

• Control Inflation or Deflation

• Availability of the Supply of money and Credit

• Integrated Interest Rate Structure

• Effective Central Banking

• Creation of Financial Institutions

 Term Loans for Industrial Development

Control Inflation or Deflation:

Monetary policy is the policy used by the government of a country to

control inflation or deflation in an economy, and this policies been

implemented by the central bank through the ministry of finance.

Availability of the Supply of money and Credit :

Monetary policy is concerned with the charges in the supply of the

money and credit. It refers to the policy measures under taken by the

government or central bank to influence the availability, cost and use

of money and credit with the help of monetary techniques to achieve

specific objectives.

Integrated Interest Rate Structure:

In an underdeveloped economy, there is absence of an integrated

interest rate structure. There is wide disparity of interest rates

prevailing in the different sectors of the economy and these rates do

not respond to the changes in the bank rate, thus making the monetary

policy ineffective. Effective Central Banking: To meet the

developmental needs the central bank of an underdeveloped country

must function effectively to control and regulate the volume of credit

through various monetary instruments, like bank rate, open market

operations, cash-reserve ratio etc.

Long-Term Loans for Industrial Development:

Monetary policy can promote industrial development in the

underdevelopment countries by promoting facilities of medium-term

and long-term loan to the manufacturing units.

Creation of Financial Institutions:

The Monetary policy in a developing economy must aim to improve

its currency and credit system. More banks and financial institutions

should be set up, particularly in both areas which lack these facilities.