Objectives of Monetary Policy

Objectives of Monetary Policy

1.    Constant Increase in Money Supply

Money supply can bring inflation in the economy, which is not a favorable situation. Similar a tight monetary policy can also bring depression to economy, which would not be good for the economy. Therefore there must be a constant and controlled increase in money supply.

2.    Stable Exchange Rate

Stable exchange rate is important for international trade. A continuous change in the exchange rate creates an uncertainty and therefore international trade suffers. Easy money policy will devalue the money and country will suffer losses on imports (imports expensive), tight monetary policy would appreciate domestic currency (foreign country will suffer).

3.    Controlling Inflation

Monetary policy can be used to control price (inflation) in the country. Inflation control is one of the fundamental aspects of monetary policy. It is important to note that many issues are linked with inflation. At the time of high inflation, tight inflation monetary policy is used to bring the prices down.

4.    Employment and Inflation

Employment can be generated with investment and investment can be attracted by easy or lenient monetary policy (lower bank rates). People would love to invest at lower interest rate and such investment will create employment.

5.    Improve Balance of payment

Government can implement tight monetary policy to boost export. Tight monetary policy will prices will fall and export will increase and thus situation of balance of payment will improve accordingly.

6.    Higher Growth

Higher growth targets can be achieved by lenient monetary policy, as lower interest rate will encourages more investment. Similarly higher investment will increase the income & saving of people and those saving will be consumed which would extend market.

Monetary Policy Instruments

Monetary Policy Instruments

Government control over the money supply & credit is known as monetary policy. Government takes various policy measures to control the money & credit supply and those policy measures collectively known as monetary policy.

Different measure adopted by the government for controlling the money & credit supply in the country is known as monetary policy instruments. These instruments are measures can be classified into two types i.e. Qualitative measures and Quantitative measures.

A.   Quantitative methods

Monetary policy quantitative methods includes bank rate changes , open market operations , changes in reserve ration by central  bank, changes in liquidity ratio.

1.    Bank Rate Change

Central bank gives advances to commercial bank. The rate at which central bank give advances to commercial banks is known as bank rate or discount rate. If central bank increases the bank rate for commercial bank, then bank will also raise their interest rate

2.    Open market operation

Central bank under operation market operation sells and purchase government securities to the general public & commercial banks. In case of inflation the government securities are sold to control money supply in the market.

3.    Reserve Ratio Changes

Commercial banks are required to maintain some deposit with central bank i.e. some percentage of its demand & time deposit. This ration vary country to country, however, typically this ratio falls between 5% to 10%.

4.    Liquidity Ratio Changes

Money supply can also be controlled with changing in the liquidity ratio i.e. ration maintained by each commercial bank for transnational needs. This ratio is based on the principal the people has deposited will require money for personal and business need and therefore bank will to maintain sufficient funds available to meet those requirements.

B.   Qualitative Measures

1.    Marginal Requirement for Loan

Central bank may increase marginal requirement for business or personal loans. For example mortgage requirement for loan (Security against loan).This increased requirement will reduce credit supply.

2.    Direct Action against Commercial bank

Central bank feel that commercial banks are not following the credit control instruction issued by central bank, then central bank can take direct action against commercial bank and stop loans of commercial bank (refusal re-discounting bills of commercial bank).

3.    Ban Consumer loan

Central may ban consumer loan for some period, because consumer is one of the key reason for high inflation in the country.

4.    Moral Guidelines

Central bank issue moral instruction and guideline to commercial bank against un productive loans. This guideline does not work in developing countries.