Monetary policy and the general objectives and instruments of monetary policy. -MBA Notes

Answer:
Monetary  policy  is  a  part  over  all  economic  policy  of  a  country.  It  is employed  by  the government  as  an  effective  tool  to  promote  economic stability and achieve certain predetermined objectives.

Monetary Policy deals with the total money supply and its management in an  economy.  It  is  essentially  a  programme  of  action  undertaken  by  the monetary authorities generally  the central bank to control and regulate the supply  of  money  with  the  public  and  the  flow  of  credit  with  a  view  to achieving  economic  stability  and  certain  predetermined  macro  economic goals.

General objectives of monetary policy. 

1. Neutral money policy:

This objective was in vogue during the days of gold standard. According to this policy, money is only a technical devise  having no other role to play. It should  be  a  passive  factor  having  only  one function,  namely  to  facilitate  exchange. 

It should not inject any disturbances.  It should be neutral in its effects  on  prices,  income,  output,  and  employment.  They  considered that  changes  in  total  money  supply  are  the  root  cause  for  all  kinds  of economic fluctuations and as such if money supply is stabilized and money becomes neutral, the price level will vary inversely with the productive power of the economy. 

If productivity  increases, cost per unit of output declines and prices fall and vice-versa. According to this policy, money supply is not rigidly  fixed.   It  will  change  whenever  there  are  changes  in  productivity, population,  improvements  in  technology  etc  to  neutralize  fundamental changes in the economy. 

Under these conditions, increase or decrease in money supply is allowed to result in either fall or raise in general price level. In  a  dynamic  economy,  this  policy  cannot  be  continued  and  it  is  highly impracticable in the present day economy.

2. Price stability:

With  the  suspension  of  the  gold  standard,  maintenance  of  domestic  price level  has  become  an  important  aim  of  monetary  policy  all  over  the  world. 

The bitter experience of 1920’s and 1930’s has made all most all economies to  go  for  price  stability.   Both  inflation  and  deflation  are  dangerous  and detrimental  to  smooth  economic  growth.  They  distort  and  disturb  the working of the economic system and create chaos. Both of them are bad as
they bring unnecessary loss to some groups where as undue advantage to some  others.

 It is to be remembered that price stability does not mean that prices of all commodities are kept constant or fixed over a period of time.  It refers to the absence of sharp variations or fluctuations in the average price  level  in  the  country.  A  hundred  percent  price  stability  is  neither possible  nor  desirable  in  any  economy.  It  simply  implies  relative  price stability.  

A  policy  of  price  stability  checks  cyclical  fluctuations  and  smoothen  production  and distribution,  keeps  the  value  of  money stable,  prevent  artificial  scarcity  or  prosperity,  makes  economic calculations  possible,  introduces  an  element  of  certainty,  eliminate socio-economic disturbances, ensure equitable distribution of income and wealth, secure social justice and promote economic welfare.

3. Exchange rate stability:

Maintenance of  stable or fixed exchange rate was one of the major objects of monetary policy for a long time under the gold standard. The stability of national  output  and  internal  price  level  was  considered  secondary  and subservient  to  the  former.  

It  was  through  free  and  automatic  imports  and exports of gold that the country was able to remove the disequilibrium in the balance  of  payments  and  ensure  stability  of  exchange  rates  with  other
countries.  The  government  followed  the  policy  of  expanding  currency  and credit  with  the  inflow  of  gold  and  contracting  currency  and  credit  with  the outflow of gold. 

In view of suspension of gold standard and IMF mechanism, this object has lost its significance. However, in order to have smooth and unhindered international trade and free flow of foreign capital in to a country, it becomes imperative for a county to maintain exchange rate stability.

4. Control of trade cycles:

Operation of trade cycles has become very common in modern economies. A  very  high  degree  of  fluctuations  in  over  all  economic  activities  is detrimental  to  the  smooth  growth  of  any  economy. 

Hence,  it has become one of the major objectives of monetary authorities to control the operation of trade cycles and ensure economic stability by regulating total money supply effectively.  During the period of inflation, a policy of contraction in money  supply  and  during  the  period  of  deflation,  a  policy  of  expansion  in money  supply  has  to  be  adopted.   This  would  create  the  necessary
economic stability for rapid economic development.

5. Full employment

Major problem  is  to  maintain  this  high  level  of  employment  situation  through various  economic  polices.  This  object  has  become  much  more  important and  crucial  in  developing  countries  as  there  is  unemployment  and  under employment of most of the resources. Deliberate efforts are to be made by  the  monetary  authorities  to  ensure  adequate  supply  of  financial resources to exploit and utilize resources in the best possible manner so as to raise the level of aggregate effective demand in the economy.

It  should  also  help  to  maintain  balance  between  aggregate  savings  and aggregate investments. This would ensure optimum utilization of all kinds of resources, higher national output, income and higher living standards to the common man.

6. Equilibrium in the balance of payments:

This objective has assumed greater importance in the context of expanding international  trade  and  globalization.  To  day  most  of  the  countries  of  the world are experiencing adverse balance of payments on account of various reasons.  

It  is  a  situation  where  in  the  import  payments  are  in  excess  of export earnings. Most of the countries which have embarked on the road to economic  development  cannot  do  away  with  imports  on  a  large  scale. Hence,  monetary authorities have to take appropriate monetary measures like deflation, exchange  depreciation,  devaluation,  exchange  control,  current account and capital account convertibility, regulate credit facilities and interest  rate  structures  and  exchange  rates  etc

7. Rapid economic growth:

This  is  comparatively  a  recent  objective  of  monetary  policy.  Achieving  a higher rate of per capita output and income over a long period of time has become  one  of  the  supreme  goals  of  monetary  policy  in  recent  years.  

A higher  rate  of  economic  growth  would  ensure  full  employment condition,  higher  output,  income  and  better  living  standards  to  the people.  Consequently,  monetary  authorities  have  to take  the  necessary steps to raise the productive capacity of the economy,  increase the level of effective  demand  for  various  kinds  of  goods  and  services  and  ensure balance  between  demand  for  and  supply  of  goods  and  services  in  the economy.

Instruments of Monetary Policy    

Broadly speaking there are two instruments through which monetary policy operates. They are also called techniques of credit control.

I. Quantitative techniques of credit control:
They include bank rate policy, open market operations and variable reserve ratio.

II. Qualitative techniques of credit controls:
They include change in margin requirements, rationing of credit, regulation of  consumers  credit,  moral  suasion,  issue  of  directives,  direct  action  and publicity etc.

# MBA Notes

# MBA Assignment Notes