Tiêu đề Chapter 6 Monetary policy.docx ✅

1 Unit VI: Monetary Policy Meaning Monetary policy is concerned with the changes in the supply of money and credit. It refers to the policy measures undertaken by the government or the central monetary authority or the central bank to influence the availability cost and use of money and credit with the help of monetary techniques to achieve specific objectives. In another words monetary policy refers to policy actions formulated, implemented and supervised by the central bank in order to achieve given macroeconomic goals(objectives) and targets by regulating volume of money supply, liquidity, BOP credit and cost of credit (interest rate) with the help of policy tools, policy framework and various rules, regulations and directives of central bank. The monetary policy basically deals with the demand side of the economy. The transmitting channels of monetary policy could be direct (i.e. money supply) and indirect (interest rate) Jan Tinbergen was the first economist to lay down certain instruments to achieve policy "a policy employing central bank control of supply of money as an instrument for achieving the objectives if general economic policy". According to R.P Kent, monetary policy is "the management of the expansion and contraction of the volume of money in circulation for the explicit purpose of attaining a specific objective such as full employment." Monetary policy is not an end in itself but a means to an end. It involves the management of money and credit for the furtherance of the general economic policy of the government to achieve the predetermined objectives. Types of monetary policy a) Expansionary (Cheap) monetary policy If the central bank pursue increase in the size of money supply, liquidity, bank credit and decrease in cost of credit (interest rate).it is known as expansionary monetary policy. It helps to increase in national, investment income, output, employment, aggregate demand for goods and services and thereby economic growth and development. b) Contractionary (dear) Monetary policy If the central bank pursue decrease in volume of money supply, liquidity, bank credit and increase in cost of capital (interest rate) it is known as contractionary monetary policy. The central bank peruses this policy during the inflation and Boom period of the economy.
2 Objective/ Goal of monetary policy Monetary policy is not an end in itself, but a means . it involves the management of money and credit for the further name of the general economic policy of the government to achieve the predetermined objectives. There have been varying objectives of monetary policy in different countries in different time and in different economic conditions. Different objectives clash with each other and there is a problem of selecting a right objectives for the monetary policy of a country. The proper objective of the monetary policy is to be selected by the monetary authority keeping in view the specific conditions and requirements of the economy. Following are the major objectives of monetary policy in general 1) Traditional Goals: it includes; a) Full Employment and its stability Full employment and its stability have 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. Full employment means a situation, in which every worker gets job who wants to work at the current wage rate. Full employment is also consistent even with the 5% unemployment in an economy. In classical economy full employment is a normal situation so that the result was also maximum level of income and output. But in modern economy, less than full employment is a common and normal situation and the result is also being below maximum level of income and output. Therefore, the first objective of monetary policy become full employment and its stability. For achieving the full employment of available resources, the level of consumption and investment spending in the economy. In the short period, the consumption spending being more or less stable, the monetary policy should aim at raising the level of investment spending by following a cheap monetary policy which will encourage borrowing for investment and through which multiplier acceleration effect will raise the level of investment. Once the level of employment is achieved, then the monetary policy can maintain it through the equalization of saving and investment. b) Economic Growth and its stability One of the most important objectives of monetary policy in recent years has been the rapid economic growth of the economy. Economic growth is defined as "the process whereby the real per capita income of a country increases over a long period of time. "Economic growth is measured by increase in the quantity of goods and services in the economy. A growing economy produces more goods and services in each
3 successive time period. Thus, growth occurs when an economy's productive capacity increases which, in turn, is used to produce more goods and services. Economic growth is a continuous process of a sustained and appreciable rise in real national income, output, employment per capita income, aggregate demand for and supply of goods and services and thereby rise in living standard of people etc. The increased goods and services should be such as to satisfy consumer wants, and the process of growth should be achieved within the framework of economic system. Therefore, the monetary policy can help the process of economic growth by minimizing changes in the level of prices and economic activity and maintaining high level of saving and investment for such monetary policy should be flexible. c) Price stability Price stability is one of the most important goal of monetary policy. Bothe economists and Layman Favor this policy measure because fluctuations in price bring uncertainty and instability to the economy. Rising and falling prices are both bad because they unnecessarily loss to some and undue advantage to others. Again they are associated with business cycle. So a policy of price stability keeps the value of money stable, eliminates cyclical fluctuations, bring economic stability, helps in reducing inequalities of income, wealth, secure, social justice and promotes economic welfare. Price stability means absence of greater fluctuations in general price level. It means a normal change in price level about 4-5% per year that will positively affect in all macro economy variables like the national investment, income, output, employment, consumption, demand, supply, balance of payment, balance of trade, etc. Inflation and deflation representing cumulative rise and fall in general price level respectively and both economically and socially undesirable situations. They create problems in production, distribution and employment to some extent. Therefore price stability should be maintained which leads to equitable distribution of income and wealth and promote economic progress and welfare in the country. In case of inflationary situation, contractionary or tight monetary policy is required to check price level. On the contrary, in the case of deflationary situation, expansionary monetary policy is needed to increase the price level. d) Exchange rate stability Exchange rate is the rate at which per unit of domestic currency is exchanged with foreign currency. In another words, exchange rate is a market value of home currency against the foreign currencies in the domestic foreign exchange market, that should be stable (nominal changed) Exchange rate stability is major objective of monetary policy. So a change in the exchange rate makes the international trade of the country uncertain. It also brings uncertainty in the price of export and imports goods. So any
4 country involved in international trade maintains a stable exchange rate. The stable exchange rate could achieve an equilibrium balance of payment of country. A monetary policy plays an important role in brings the balance of payment to maintain the stable exchange rate. Exchange rate instability creates many problems, in export, imports, money and capital market, exchange market, credit operation, debt management, and flow of goods and service etc. which is not good for a suitable economy. Therefore, the objective of monetary policy to exchange rate stability. e) Neutrality of money supply Certain economists like Wicksteed, Koopmans, Hayek, Robertson etc. advocate that the objective of the monetary policy should be to keep the money neutral, i.e. to ensure that the quantity of money in circulation does not affect the prices. These economists believe that business fluctuations occur because of the changes in the quantity of money in circulation and if the disturbances caused by monetary change could be controlled or eliminated, then instead of vigorous fluctuations, only smooth adjustments to change in technology, consumer's preferences or acts of God will take place in the economy. Therefore, neutrality of money supply means a proportionately change in money supply with respect to the change in price level for making constant money supply in real term. If it is not neutral, it will negatively affect in major macro economy variables like national income, investment, output, employment, consumption, saving, exports, imports and balance of payments etc. Hence, neutrality of money supply becomes one of the objectives of monetary policy. f) Healthy(surplus) Balance of Payment Balance of Payment (BOP) is a comprehensive record of all visible and invisible records of all economic transactions of a nation with other countries during a given period of time i.e. during a particular fiscal year. Here, healthy BOP means the positive gap between the total inflow and outflow of foreign currency of a given national in a given fiscal year. If the BOP is deficit, that will make weaker national economy in the foreign market and also it makes delay to attain other objectives of monetary policy. So, the healthy BOP is taken as one of the major objective of monetary policy. The developing countries like Nepal, imports goods like machinery equipment, raw materials, fertilizers, petrol in large quantities for development works. They exports primary products with low value in limited quantity. Hence they face Balance of payments problem. That adverse BOP can be corrected through monetary policy. The exchange rate should be stable. For this purpose, the institutions like trade promotion