Monetary policy1. The process by which the monetary authority of a country controls the supply of money.2. Targeting a rate of interest for the purpose of promoting economic growth and stability.3. Goals include relatively stable prices and low unemployment.
Expansionary & contractionary An expansionary policy increases the total supply of money in the economy more rapidly than usual. Contractionary policy expands the money supply more slowly than usual or even shrinks it.
Neutrality of money Any monetary change is the root cause of all economic fluctuations. The monetary authority should aim at neutrality of money in the economy. Exchange stability It is the traditional objective of monetary authority. Monetary policy will correct the disequilibrium in the balance of payments and exchange stability will be maintained.
Price stability It is the genuine objective of monetary policy. Cyclical fluctuations are totally eliminated by monetary policy. It ensures equitable distribution of income and wealth. Full employment The main objective of monetary policy of a country is to bring about equilibrium between saving and investment at full employment level. Economic growth It implies an increase in the total physical or real output, production of the goods for the satisfaction of human wants.
A. Quantitative controls 1. Open-market operations It comprises sales and purchases of government securities and treasury bills by the central bank of the country. To increase the supply of money, it purchases the securities. To reduces the money circulation, it sells the government bonds and securities. Most powerful and widely used tool.
2.Discount rate or bank rate policy It is the rate at which the central bank rediscounts the bills of exchange presented by the commercial banks. For rediscounting the bills of exchange , the central bank charges a rate called bank rate. Simply , bank rate is the central bank charges on the loans and advances to the commercial banks.
3.Cash Reserve Ratio (CRR) IT is the percentage of total deposits which commercial banks are required to maintain in the form of cash reserve with the central bank. The objective of CRR is to prevent shortage of cash in meeting the demand for cash by the depositors. Cash reserve is non- interest bearing CRR is a legal requirement .So it is called statutory reserve ratio (SRR).
B. Qualitative or selective methods 1.Changes in marginal requirements Under this method, the central bank effects a change in the marginal requirement to control and release funds. 2. Direct action This method is adopted when some commercial banks do not co-operate with the central bank in controlling the credit. 3. Rationing of the credit The central bank fixes a limit for the credit facilities to commercial banks.
Supply of money:- it refers to the currency issued by the monetary authority and demand deposits lying in the banks. Cost of money or rate of interest:- The LDCs should adopt money policy to promote agriculture and industrial sectors. this discriminating policy of rate of interest is favoured in priority sectors. In order to reduce the aggregate demand, rate of interest should be raised. This will result in reduction of availability of money.
1.Under-developed money market Due to the unorganized nature of the money market and lack of its integration with the central bank, the traditional methods of credit control have got limited effect.2. Non-monetized sector Due to the existence of an extensive non- monetized sector, changes in the money supply of the country or the change in the interest rate do not have any effect on the level of economic activity.
3. Shortage of real factors Another problem in developing countries exists that there is a shortage of real factors like capital, entrepreneurial ability, etc.4. Lake of banking facilities In a developing economy, adequate banking facilities are not available. So the idle savings of the people cannot be mobilized.5. Black money In under developed countries, large quality of black money due to political and economic factors.
i LM1 LM2 If the central bank engages in a monetary expansion, the LM curve shifts down. The IS stays A still. The equilibrium moves i1 from A to B indicating a higher i2 B level of output and a lower level of interest rate. IS Y1 Y2 Y 13
1. Consumption(C): Consumption increases since income increases.2. Investment(I): A monetary expansion gives a twofold boost to investment3. Government(G): Government expenditures are unchanged.4. Taxes(T): Taxes are unchanged. 14