Functions of Money

The functions of money can be conveniently divided in to three parts (A) Primary (B) Secondary and (C) Contingent functions. These functions are briefly discussed as under. (A) Primary Functions: (i) Money as Medium of exchange: In all market transactions money is used to pay for goods and services. The sale or purchase of goods is done through money. Money in other words acts as medium of exchange and helps in overcoming the difficulty of double coincidence of wants of barter economy. (2) Money as a unit of account: Another important function of money is that it provides a unit of account. The monetary unit of account is used to measure the value of goods and services in the economy. Just as we measure weights in terms of kilograms or distance in kilometres similarly we measure and compare the value of goods and services in terms of money. (3) Money as standard of deferred payments: Another function of money is that it is used as mean of setting debts maturing in the future. In modern economy most of the business is done on credit. Goods are bought and sold on the promise to pay money on a certain date in future. Debts are stated and paid in terms of units of account. (4) Money as a store of value: Money also functions as a store of value. It is a reservoir of purchasing power overtime. The money which you have today can be set aside to purchase things later on. This function of money is useful because most of us do not to spend our income immediately upon receiving it. They prefer to wait until they have the time or desire to spend it. B. SECONDARY FUNCTIONS OF MONEY Money as potential to influence the economy. It influences the price level, interest rates, utilization of resources etc. The secondary functions of money in brief are 1. Aid to specialization, production and trade: The use of money has helped in removing the difficulties of barter. The market mechanism, production of commodities, specialization, expansion and diversion of trade etc have all been facilitated by the use of money. 2. Influence on Income and consumption: The use of money has direct bearing on levels of income and consumption in the country. All production takes place for the market and the factor payments are made in money. 3. Money as an instrument of making loans: People save money and deposit it in banks. The banks and advance these saving to businessmen and industrialists. Money is thus the instrument by which saving are transferred into investment. 4. Money as a tool of monetary management: Money is an important tool of monetary management. If the money is effectively used it helps in increasing output and employment. 5. Instrument of economic policy: Money is an important instrument of economic policy. In order to achieve growth, reduce unemployment and maintain regular expansion of economic activity money is the most powerful factor. C. CONTINGENT FUNCTIONS Contingent functions are derived from primary and secondary functions. Contingent functions of money are as follows. (i) Distribution of national income: Money facilitates the distribution of national income among various factors of production. (ii) Basis of Credit system: Banks create credit on the basis of their cash reserves. Any change in the volume of money is brought about mainly by an increase or decrease in money supply. (iii) Measure of Marginal Productivity: The marginal productivity of each factor of production is measured with the help of money.

(iv) Liquidity of Property: Money gives liquid form to wealth. A property can be converted into liquid form with the use of money.

Price Stability
The general rise in the level of prices represents inflation, while the general fall in the level of prices is called deflation. Both these situations are undesirable. Therefore monetary policy is used to stablize the prices. Because of the price stability. (1) The negative effects rising in an economy will come to an end. (2) The price stability will not allow the depression or boom to occur. (3) The future value of money can easily be assessed, and everybody will accept it for future payments without any hesitation. (4) The price stability will not encourage unequal income distribution. (5) Because of the price stability the rising prices during inflation and falling prices industry deflation could be controlled. (6) The Stable prices lead to stagnation in the economy. As if producers and labour not possessing the incentives in the form of more profits and wages their efficiency will be affected. (7) Because of the changes in price level the resources allocation, investment, direction and choice of technique like issues are easily resolved. (8) Because of the constant price level the fixed income group would develop the realization that their wages, pensions, rents and interest etc will remain the same. When their incomes do not increase they will fail to avail the luxuries of life. (9) The price stability is not possible because monetary policy can not encompass the whole economy. The monetary policy can maximally influence the activities of commercial banks. The non-bank financial institutions and foreign bans have their own policies which are hardly influenced by the changes in monetary policy. Keeping above given points in for and against the price stability in view it can be concluded that it is not possible practically that the prices could remain stable or constant at a particular level. Therefore economists think that the monetary policy be devised in such a way that the rising prices and falling prices both should remain under control. It means that neither the pries should rise very sharply nor should fall very rapidly.

Money Market
Money market is a financial market for short terms loans. It is a market for short term borrowing and lending of funds. It is defined as a financial market in which only short term debt instruments having maturity of less than one year are traded. The main features of money market are given as under. (i) Money market has buyers and sellers in the form of borrowers and lenders. The borrowers are the traders, manufactures, speculators. The lenders in the money market are the Central Bank, Commercial Banks etc. (ii) It deals with short term credit instruments such as Treasury bills of exchange etc. (iii) Money market securities are more widely traded and are liquid. (iv) Short term securities have smaller fluctuation in prices. Therefore they are considered sage investment. (v) Money market operates through various financial institutions such as Central bank,

Commercial banks, non bank financial intermediaries, bill brokers. (vi) Money market is not a single homogenous market. It is composed of several sub markets. Each market deals with specific short term credit instruments e.g. call money market, trade bill market etc.

Liquidity Preference
In the words of Meyer Liquidity Preference is the preference to have an equal amount of cash rather then to claims against others. According to Keynes interest is purely a monetary phenomenon people prefer to hold a part of their incomes and wealth in liquid form. People become willing to part with liquidity only when they are offered same reward in the form of interest liquidity preference means the demand for money to hold cash. Keynes is of the view that rate of interest is determined by the demand for (liquidity preference) and supply of money. Keynes has given three motives for holding money in liquid form. 1. Transaction Motive: The transaction motive relates to the demand for money or the need for cash for the current transactions of individual and business exchanges. Individuals hold cash in order to bridge the internal between the receipt of income and its expenditure the businessmen and the entrepreneurs also have to keep a proportion of their resources in ready cash in order to meet their current needs of various kinds. In the case of individuals Keynes calls it Income motive and in case of businessmen it is called by him Business motive. 2. Precautionary Motive: Precautionary motive for holding money refers to the desire of the people to hold cash balance for unforeseen contingencies. People hold a certain amount of money to provide for the danger of unemployment, sickness, accidents and other more uncertain perils. This amount of money held under this motive will depend on the nature of the individual and the conditions in which he lives. 3. Speculative Motive: The Speculative motive relates to the desire to hold ones resources in liquid form in order to take advantage of market movements regarding the future changes in the rate of interest.

Full Employment
The classical economists believed that there was always full employment. According to them full employment is a situation when there is no involuntarily unemployment, through there may be voluntarily, casual, seasonal, structural, technological and frictional unemployment. In their opinion in a free competitive economy serious unemployment was passing phase. All job seekers are able to find jobs sooner or later at the prevailing wage rate. This view however is not accepted by economists these days. Actually there is always some unemployment. Employment will be full literally when every able bodied adult worked the number of hours considered normal for a fully employed person at the current wage level. This level of employment, however normally appears to be unattainable in private enterprise economists. For, under such economics, quite a few have enough unearned incomes to be able to afford a life of well-paid idleness. Pigou accordingly defied full employment as one when every body who at the ruling rate of wages wishes to be employed is infact employed.

But even Pigovian full employment appears to be unattainable for, at any given time, there is bound to be some seasonal and frictional unemployment. This led Keynes and after him to define full employment as a level of employment which falls short of Pigovian full employment. The Economic and Social Council of the UN has accepted the same definition for it required countries to fix full employment standard in this sense. Keynesian full employment is by definition the maximum level of employment that private enterprise countries can attain without experiencing strong inflationary pressure. According to Keynes full employment is a situation in which aggregate employment is inelastic in response to an increase in effective demand for its output. But for purpose of practical policy it is necessary to reduce the concept to quantitative terms. It should be possible to say precisely when employment is less than full so that remedial measures can be adopted to achieve the full employment level.

Index Numbers
Index numbers are devices for measuring the difference in the magnitude of a group of related variables. An index number of prices is that a number which indicates the price level of any given dete as compared with the level of prices at some standard dete called the base. PREPARATION OF INDEX NUMBERS The following are the various steps in the construction of an index number. (i) Choice of the base year: The first step is to choose a year to serve as the base year i-e the year with reference to which the price changes n other years are expressed as percentages. Care must be excised in its selection. It should be an average year, neither a year of boom nor of depression. (ii) Selection of Commodities: The second step is to select commodities the prices of which have to be taken to represent the general price level. The commodities should be really representative and should be sufficiently large in number. The selection of commodities also depends on the object with which the index is prepared. (iii) Price Lists taken for each commodity: It is better to have an average of wholesale prices of the same commodity from a number of representatives markets. These prices are taken for the base year and also for the subsequent years the index number for which we want to construct. Retail prices are better because it is the retail prices which consumers actually pay. But retail prices are not taken because they differ widely from locality to locality. (iv) Price of each commodity: The next step is to represent the price of each commodity for the base year as 100 and the price of the same commodity for the subsequent year as a percentage of the price for the base year. For instance of the price of wheat in the base year is Rs. 70 per quintal and is called 100 of Rs. 154 in the subsequent year should be called 220 and so on in the case of all the commodities taken and all the years. (v) The Final step: The final step is t strike the average of the numbers thus obtained with reference to each year. The average for the base year will to course come to 100. The other average will be higher or lower than 100 according as the general price level has risen or fallen.

International Development Association

The establishment of the International Development Association (I.D.A) was another step in the direction of increasing international liquidity in the World. The I.D.A was setup in September

1960, as a subsidiary of the World Bank to provide soft loans to the member countries. In other words the object of the I.D.A was to provide loans to the member countries on liberal terms with regard to the rate of interest and the period of repayment. The interest charged on the I.D.A loans was lower than that of the World Bank. Jurther the borrowing countries were allowed longer periods, say 50 years or so, for repayment of loans. Besides the loans taken by the member countries could be repaid in their own national currencies. They were under no obligation to repay the loans in hard currencies as was the case with the World Bank. It is on this ground that the I.D.A is often referred to as the Soft Loans Window of the World Bank. The I.D.A has its own criterion for investment in developing countries. The project to be selected for financial aid should be of a high development priority. The project should be such as to help the country in saving its foreign exchange resources during the course of its fulfilment. The I.D.A gives loans to private industrial undertakings without any guarantee from the government of that country. MEMBERSHIP, CAPITAL AND ORGANIZATION OF I.D.A The membership of the I.D.A is open to all those countries which are members of the World Bank. The I.D.A was started with an initial capital of 1,000 million dollars collected from member countries. The capital resources of the I.D.A have been increased from time to time to meet the increasing requirements of the member countries. The subscriptions from the member countries are payable to the I.D.A in five annual instalments. The I.D.A has divided its member countries into two parts. Part I comprises 21 countries and Part II includes 99 countries. The countries included in Part I happen to be rich and affluent with higher income per capita. NATURE OF I.D.A ASSISTANCE I.D.A provides soft loans to the member countries which are generally interest free. But there is a nominal service charge of 3/4 percent on the amount of outstanding loans. This charge is intended to cover the administrative expenses of the I.D.A. The I.D.A provides long term loans repayable over a period of 50 years with an initial grace period of 10 years. No repayment is to be made during the initial period of 10 years. Afterwards 1 percent of the principal amount of the loan is repayable annually for a period of 10 years and during the next 30 years the balance of the outstanding loan is to be amortized at an average rate of 3 percent per annum. The I.D.A provides loans for such projects as water supply, sanitation, health, education urban development etc, which do not make immediate contribution to the economic development of the country.

International Finance Corporation and its Objectives

The International Finance Corporation (I.F.C) is an affiliated institution of World Bank. It was established on July 20, 1956 with the object of assisting private enterprises in developing countries by providing them with risk capital. The World Bank grant loans only to member governments or private enterprises with the guarantee of member government concerned. Again the World Bank provides only loan to private enterprises. Infact the development of private enterprises is held up for lack of adequate risk capital. Hence there was an urgent need for some international finance institution which would be willing to provide risk capital to the private industrial undertaking in developing countries. The I.F.C was set up to meet the participation requirement of private industrial undertakings. OBJECTIVES OF THE I.F.C The main objectives of the I.F.C is to accelerate the pace of economic development of the member countries in the under developed areas of the world in these ways.

(i) By investing in private productive enterprises in association with private investors and without any government guarantee of repayment. (ii) By bringing together investment opportunities, private capital, both foreign and domestic and experienced management. (iii) By stimulating productive investment of private capital, both foreign and domestic, in the developing countries for productive purposes. MEMBERSHIP OF THE I.F.C As already pointed out that the I.F.C is an affiliate of the World Bank. Its membership is separate from that of the World Bank. But it is only the members of the World Bank who can become members of the I.F.C. It is not essential that all the members of the World Bank should also be the members of the I.F.C, is optional for the members of the World Bank. Total membership of the I.F.C at present is 161. ORGANIZATION OF THE I.F.C All the powers of the I.F.C have been vested in the Board of Governors. There is one Governor from ach member country nominated by government of that country. The Board of Governors normally meets once a year to chalkout the general policy of the corporation. The general business of the I.F.C is carried on by the Board of Directors which meets at least once a month. There are 21 Executive Directors who constitute the Board of Directors of the corporation. The President of the World Bank is ex-officio Chairman of the Board of the Directors of I.F.C. Subject to this over all supervision, the day-to-day routine working of the corporation is conducted by the Executive Vice-President. CAPITAL OF THE I.F.C The Corporation was started in July 1956 with an authorized capital of 100 million dollars. The capital has been increased from time to time to meet the increasing requirements of the corporation. The Board of Directors has decided to double the authorized capital of I.F.C to 1,300 million dollars. The corporation has also been borrowing funds from the World Bank to supplement its financial resources. INVESTMENT CRITERIA OF THE I.F.C While extending financial assistance to enterprises the Corporation keeps following points in view. 1. The borrowing enterprises should be expected to make profits in course of time. Infact profitability is an essential criterion for loans to be made by the I.F.C. 2. The borrowing enterprises should be such as to make a definite contribution to the economic development of the country in which it is located. 3. The corporation is prevented by its Charter to invest more than 22 million dollars in any single venture. 4. The corporation can make investment in a private enterprises only if more than 50 percent of the capital is forth from that enterprise itself. 5. So far as the equity is concerned the Corporation cannot provide more than 25 percent of the aggregate capital of the borrowing enterprise.

International Bank for Reconstruction; its Functions and Objectives

The International Bank for Reconstruction and Development (I.B.R.D) better known as the World Bank was established at the same time as the International Monetary Fund to tackle the problem of International investment in 1944. Since the I.M.F was designed to provide temporary

assistance in correcting balance of payments difficulties, there was need of an institution to assist long term investment purposes. Thus I.B.R.D was established for promoting long term investment loans on reasonable terms. The World Bank is an inter-government institution corporate informs the capital stock of which is entirely owned by its member governments. Initially only nation there were members of the I.M.F could be members of the World Bank but the restriction on membership was subsequently released. FUNCTIONS OF I.B.R.D The principal functions of the I.B.R.D are set forth in Article (1) of the Agreement as follows. 1. To assist in the reconstruction and development of the territories of its members by facilitating the investment of capital fro productive purposes. 2. To promote private foreign investment by means of guarantee of participation in loans and other investments made by private investors and when private capital is not available on reasonable terms to make loans for productive purposes out of its own resources from funds borrowed by it. 3. To promote the long term balance growth of international trade and the maintenance of equilibrium in balances of payments by encouraging international investments for development of productive resources of members. 4. To arrange loans made guaranteed by it in relation to international loans through other channels so that more useful projects, large and small alike, will be dealt with first. OBJECTIVES OF I.B.R.D The objectives of I.B.R.D as incorporated in the Articles of Agreement are as follows. 1. To help in the reconstruction and development of member countries by facilitating the investment of capital for the productive purposes, including the restoration and reconstruction of economies devastated by war. 2. To encourage the development of productive resources in developing countries by supplying them investment capital. 3. To promote private foreign investment through guarantees and participation in loans and other investment made by private investors. 4. To supplement private foreign investments by direct loans out of its own capital for productive purposes. 5. To promote long term balances growth of international trade and the maintenance of equilibrium in the balance payments of member countries by encouraging long term international investments. 6. To bring about an easy transition from a war economy to a peace time economy. 7. To help in raising productivity, the standard of living and the conditions of labour in member countries. The World Bank advances loans to member countries primarily to help them lay down the foundation of sound economic growth. The loans made by the Bank either directly or through guarantees are intended for certain specific projects of reconstruction and development in the member countries. LENDING PROCEDURE OF I.B.R.D The I.B.R.D advances loans to member countries in the following three ways. 1. Loans out of its own Fund: As we know that the Bank collects capital contributions from its members this results in the creation of a sizeable fund out of which the Bank advances loans to the needy member countries.

2. Loans out of borrowed Capital: Sometimes the Bank does not grant loans out of its own funds. It borrows funds from another member country for the purpose of giving loans to the needy members. The Bank pays interest to the member country from which it has borrowed funds for a specific period of time. 3. Loans through Banks guarantee: Sometimes the Bank encourages the private investors of a country to lend their funds to an other country by guaranteeing the repayment of loans and interest there on. Ordinarily the Bank does not lend to the member countries out of its own funds. The Bank lends out of its funds only when private investors in member countries are not forthcoming to make loans to the concerned country.

I.M.F; Objectives and its Advantages

There was complete lack of monetary cooperation amongst the countries of the world after the First World War. A sort of economic war was going amongst the majority of the countries of the world. Infact the Second World War broke out primarily on account of these economic causes. During the closing years of war an international monetary conference was held at Bretton Woods in the U.S.A. in July 1944 to prepare a plan to root out the economic causes leading to the out break of war. The Bretton Woods Plan was divided into two parts (1) the establishment of I. M. F. and (2) the setting up of World Bank. I. M. F. started functioning on the 1st march 1947. OBJECTIVES OF I. M. F. Following are the objectives of I. M. F. 1. To bring about international monetary cooperation. 2. To ensure stability in foreign exchange rates. 3. To eliminate exchange control. 4. To establish system of multinational trade and payments system. 5. To promote international trade. 6. To help member nations to achieve balanced economic growth. 7. To eliminate of to reduce the disequilibrium in the balance of payments. 8. To promote investment of capital in backward and under developed countries. CAPITAL AND ORGANIZATION The capital of the I. M. F. consists of the aggregate of the quotas allotted to member countries. Each member pays either 20 percent of quota or 10 percent of its entire gold and dollar holdings, whichever is less, in gold. The balance of quota is paid to the I. M. F. in the national currency of the member country. The quota as of member countries of the I. M. F. are normally revised once every five years. There are two bodies to run the management of the I. M. F. (a) The Board of Governors and (b) The Board of Directors. Every member country appoints one Governor to participate in the meetings of the Board of Governors. The Board of Governors formulates the general policy of the Fund. There are 21 members in the Board of Directors. Seven of then are permanent members, while fourteen are elected from amongst the remaining members. According to the Fund Agreement, the headquarters of the Fund are located in a country which happens to have the highest quota of capital of I. M. F. The head office of the Fund is at present located in Washington. FUNCTIONS OF THE I. M. F. There are three important functions of the Fund. They are (1) The Fund helps the member countries to eliminate or at least to minimize the short period disequilibrium in their balance of

payments. (2) The Fund also helps the member countries to remove the long period disequilibrium in their balance of payments. (3) The Fund tenders advice to the member countries on economic and monetary matters, because it is in a position to do so in view of its special quota. ADVANTAGES OF THE FUND Following are the main advantages which have occurred to the world from the functions of the Fund. 1. Establishment of a Monetary Reserve Fund from which foreign exchange requirements of various are met. 2. Setting up of multilateral trade and payments system. 3. Improvements in short term disequilibrium in balance of payments. 4. Stability in foreign exchange rates. 5. Check in competitive currency devaluation. 6. No interference in domestic economic affairs. 7. Gains of Gold Standard. CRITICISM OF THE FUND The functions of the Fund is often subjected to the criticism on the following grounds. 1. Limited scope of the functioning of the Fund. 2. Quota fixation is on unscientific basis. 3. Discriminating treatment. 4. Inability to remove exchange controls. 5. No success in securing exchange stability. 6. No provision for automatic revaluation of currency. 7. No solution of the liquidity of problem. 8. Failure to tackle the problem of pertro-dollars. 9. No elimination of multiple exchange rates. 10. Free convertibility of currencies not attained. 11. Inadequate representation to developing countries. 12. Provision of inadequate resources to developing countries. Erosion of sovereignty of poor nations.

Limitations of Monitary Policy

Now we see the limitations in the ways of effective role of monetary policy in case of developing countries like. Main points about limitations are discussed as under. 1. In case of under-developed countries the money and capital markets are very immature. The banking system is backward and there operates non-monetization in the economy. Above all the major parts of transactions are made with the help of cash, where as the use of cheques and drafts are very limited. The saving schemes are not very attractive. As a result, people are bound to keep their savings in the form of gold and hoardings. 2. There exists a traditional type of banking in the poor countries where banks provide more loans to commerce while reduced loans are given over industrial and agricultural sectors. Perhaps it is due to long period of time and element of uncertainty. If Central Bank inducts cheap money policy for economic development its benefits are mostly availed by speculators a hoarders while the neglected sectors remain deprived of. It shows that easy monetary policy

leads to create artificial shortages, regional imbalances and unequal income distribution, rather being helpful in economic development. Thus monetary policy aggravates the problems of developing countries. 3. In case of developing countries the money market is extremely backward. It is fragmented into organized and unorganized money markets. The organized money market is located in cities where bank and specialized institutions provide loans at concessionary rates. While the unorganised money market is located in villages where there is dearth of banks and financial institutions. The Zamindars, money lenders and merchants provide these loans at a higher rate of interest. Above all, the monetary policy will have a least influence over unorganized money market and central bank is pursuing easy monetary policy. 4. In case of poor countries there is limited business regarding stocks, shares and securities. The stock exchanges are confined to few big cities. Central Bank follows a very conservative and orthodox way regarding sale of securities. There is a limited publicity in respect of public loan. The Government security market is neither deep nor elastic. More over, so many financial institutions like co-operative banks etc are least affected by monetary policy. They have them own structure of rate of interest, rigid and inflexible even in the presence of easy monetary policy. 5. In case of under-developed countries the unemployment is not of cyclical nature, which could be removed with easy monetary policy. Rather it is concerned with disguised and underemployment. Accordingly the role of monetary policy is different in under-developed countries. Accordingly there is a need to adjust monetary policy to the circumstances prevailing in the backwards countries. In case of developing countries monetary policy can play its effective role when. (A) Such a rate of interest structure could come into being which is flexible upward as well as downward. Moreover the benefits of cheap money policy should not be taken away by speculators and hoarders. (B) If the loans provided under cheap credit money policy are transmitted over to goods sector i.e they are used for speculation a shortage goods will develop. Hence the economy may experience inflation. The inflation will sabotage the process of development. Therefore central bank will have to keep an eye over the speculative demand for money. The loans for unproductive uses will have to be encouraged. (C) The major part of bank loans is taken away by businessmen while the small traders and agriculturists fail to get the loans. Thus to remove such disparity and proper distribution of loans the central bank should encourage the opening of new banks which could provide loans neglected persons and sectors. Co-operative banking be promoted. As a result not only the savings will increase, but the loan availability will also become possible. (D) In countries like Pakistan there always exists a danger of inflation. It is because of the reason that outputs cannot be increased to the desirable extent. There is a big population pressure. The government expenditures are far more than government revenues. The trading is carried under speculation and hoarding. In such like circumstances, the selective credit controls are more useful i.e central bank restricts the speculative and consumer credits. In the light of above mentioned cases if monetary policy is reformulated it can play an effective role in the economic development of developing countries.

Role of Monitary Policy

Now-a-days the monetary policy is very important both for the developed as well as for the developing countries. We can have the idea about the role of monetary policy for the developing countries like Pakistan from the points explained below. 1. The under-developed countries are aimed at a balanced economic growth, particularly they want to develop their backward regions and utilize the labour, capital and other natural resources at their disposal in a best way. For this purpose monetary policy can be helpful to us. As the loaning facilities to backward regions can be extended, the cheaper credit may be made available to the preferred regions and sectors, and more loans at cheaper rates for neglected areas can also be provided to start the process of economic development. 2. The economic development of a country depends upon technical changes, inventions and innovations and discovery of new models etc whether they have been imported of formulated at domestic level. Accordingly, monetary policy has to play its role for the sake of technical progress and inventions etc. As the producers who want to produce new goods can be provided the credit at soft conditions. In this way the process of development can be started. 3. The economy which is engaged in the process of economic development is in need of more capital so that the transaction of goods and services could easily be facilitated. The availability of more money will put to an end the non-monelized sector in the poor countries. The backward and self sufficient life of villages will come to an end. 4. Economic growth and industrial growth are compulsory to each other. The industrial growth can be possible if loans are provided in a greater amount. The entrepreneurs with greater funds would utilize the resources and produce more goods. The availability of loans can be made possible through money and capital market. The monetary policy can be helpful in establishing the monetary institutions.

Price Stability and Balance of Payments

There appears to be no conflict between the objectives of price stability and balance of payments in country. Monetary policy aims at controlling inflation to discourage imports and encourage exports and thus it helps in attaining balances of payments equilibrium. However if the government tries to remove unemployment and allows some inflation with in the economy, there appears a conflict between these two objectives. For a rise in the price level will discourage exports and encourage imports, thereby leading to disequilibrium in the balance of payments. But this may not happen if prices also rise by the same rate in other countries of the world.

Full Employment and Balance of Payments

There is a major policy conflict between full employment and balance of payments. Full employment is always related to balance of payments deficit. Infact the problem is one of maintaining either internal balance or external balance. If there is balance of payments deficit, then a policy of reducing expenditure will reduce imports but it will lead to increase in unemployment in the country. If the government raises aggregate expenditure in order to increase employment, it will increase the demand for imports there by creating disequilibrium in the balance of payments. It is only when the government adopts expenditure-switching policies such as devaluation that this conflict can be avoided but that too temporarily.

Full Employment and Price Stability

One of the objectives of monetary policy in 1950s was to have full employment with price stability. But the studies of Phillips, Samuelson Solow and others in the 1960s established a conflict between two objectives. They suggest that full employment can be attained by having more inflation and that price stability can be achieved by having unemployment to the extent of 5 to 6 percent. Economists do not find any conflict between unemployment and price stability. They hold that so long as there are unemployed resources, there will be price stability. Prices start rising only when there is full employment of resources.

Economic Growth and Price Stability

There is a conflict between the goals of economic growth and price stability. The rise in prices is inherent in the growth prices. The demand for goods and services rises as a result of stepping up of investments on a large scale and consequent rise in prices especially when the level of full employment is reached. In the long run when new resources are developed and growth leads tot eh production of more commodities, the inflationary rise in prices will be checked. But the rise in prices will be there with the growth of the economy and it will be moderate and gradual.

Full Employment and Economic Growth

The majority of the economists hold the view that there is no inherent conflict between full employment and economic growth. Full employment is consistent with 4 percent unemployment in the economy. So the relationship between full employment and economic growth boils down to trade-off between unemployment and growth. Periods of high growth are associated with low level of unemployment and periods of low growth with rising unemployment. In 1961 Aurther Okun established relationship between real GNP and changes in the unemployment rate. This relation has come to be known as Okuns law. This law states that for every three percentage points growth in real GNP, unemployment rate declines by one percentage point every year. However certain economists argue that unemployment rate increases as the growth rate rises. Economic growth leads to reallocation of resources in the economy where by there is change in the type and quantity of labour demanded. There is a shift in the demand for labour from one sector of the economy to the other. As workers are trained for specific jobs, they are displaced when the demand for the products of particular industries falls. This creates unemployment. This is particularly so when growth is the result of technological innovations which are labour saving and require more qualified and skilled workers. Thus unskilled workers are worst sufferers because they are thrown out of jobs with automation. Employment can however increase with growth if demand is increasing at 3 percent per annum and the productivity is increasing at 4 percent per year, thou put will expand by employment will decline. Under the circumstances the government should adopt such monetary policy which should increase the overall demand in the economy.

Instruments and Techniques of Monetary Policy

Monetary policy mainly aims at controlling the volume of credit in the country and sometimes also the direction of its use. It is not possible to describe in detail the methods by which this is done, for which reference may be made to any good book on the theory of money and banking. A brief mention of them, however must be made for completeness of our discussion. Monetary policy may achieve credit control in various ways depending upon whether the control desired is quantitative control or qualitative control. The former refers to the volume of purchasing power and latter to the use to which it may be put. (a) QUANTITATIVE CONTROL The methods of quantitative control include the following. (i) Bank Rate Policy: The Central Bank of the country raises or lowers as needed, its Bank Rate (discount rate) for first calls paper thus influencing other interest rate sin the money market. A higher rate discouraged and lower rate encourages bank loans ad hence credit expansion. Thus is regulates and controls the volume of purchasing power in the economy for carrying on economic activities. (ii) Open Market Operations: The Central Bank buys or sells, as the need may be, Government securities in the open market. By purchasing the securities it adds to the balances of commercial banks with itself and by selling them it reduces such balances. Balances with the Central Bank being as good as cash, such operations expand and restrict respectively the power of commercial banks to create credit when they sell of buy such securities. (iii) Variable Reserve Ratios: The Central Bank requires a certain percentage of the liabilities of commercial banks (or member banks) to be kept in form of reserves with it under the law. This ratio can be increased when credit contraction is desired and decreased when the object is to expand credit. (iv) Credit Rationing: The Central Bank may put limits on the issue of credit (overall or for particular purposes) on the part of the member banks. These limits may be increased or decreased as needed by the monetary situation in the country. (b) QUALITATIVE CONTROL It includes following. (i) Moral Suasion: Central Bank through direct advice or persuasion may influence the banks to follow particular lines of policy considered necessary to meet a particular situation. (ii) Consumer Credit Regulation: In times of inflationary pressure the Central Bank may put restrictions on loans to consumers. If consumption needs encouragement the Central Bank may allow commercial banks to advance loans for consumption. (iii) Publicity: This method is used usually accelerating the pace of economic development. This implies issuing of weekly statistics, periodical reviews about money market conditions, public finance, trade, industry, weekly balance sheet etc for the information of commercial banks, this convincing them of the desirability of following particular lines of policy. (iv) Variable Margin Requirements: Margin requirements may be increased if the object is to discourage, and decreased if the aim is to encourage credit only for speculative activities in the stock exchange. (v) Direct Action: This method is used by Central Bank usually to rediscount bills of banks following policies which are inconsistent with the Central Banking policy. This method is rarely used and only as last resort. To be fully effective in achieving their aims these methods pre-suppose a well-developed money market which is sensitive to the actions taken by the Central Bank. If there is a large nonmonelised sector and net of banking institutions is not wide enough to cover the country, or there

is absence of organised banks prepared to cooperate in the national interest monetary policy will face difficulties in achieving its objectives.

Monetary Policy and its Objectives

The monetary policy of a country consists of various measures usually taken by its Central Bank but ultimately reflecting Government policy to seek to influence the supply of and demand for money and the various uses to which loanable funds may be put. The objectives of monetary policy are achieved through influencing the lending policies of banks which affect the flow of purchasing power and its direction in the country. The main objectives of monetary policy may be divided into two broad categories. (i) Those of minor scope: This category includes such objectives as stabilisation of money market, protection of the monetary standard, elimination of undesirable fluctuations in foreign exchange rates, maintaining stability of inter prices, avoidance of undue fluctuations in interest rates etc. These objectives, however remain in the background of the monetary policies of the present day economies and are subordinated to the major objectives, and hence are given comparatively small importance. (ii) Those of major scope: The major objectives of monetary policy have varied under difference monetary systems, under the gold standard, safeguarding the gold reserve from internal and external drains was given the chief importance. During the thirties of the present century the major objective of monetary policy was considered to be achievement and maintainance of full employment. This was natural in view of the universal phenomenon of unemployment prevailing during the Great Depression. During World War II and the post war period control of inflation become a major task. One may say that some thing out of business fluctuation has remained one of the major objectives of monetary policy, particularly in the industrially developed countries. Closely connected with this has been the objective of Cheoxing the tendency towards that is called secular stagnation and to impart a healthy buoyancy to the economy. At present the problem of inflation dominates the scene almost everywhere outside the socialist world. For less developed world the major objectives of monetary policy has been to promote activities resulting in economic development or optimum utilisation of their material and human resources. In Pakistan monetary policy must be geared to the needs of her planned economic development in addition to tackling the current problem of high inflationary pressure.

Selective Credit Control

Qualitative or Selective credit control is a recent development in monetary management by the Central Bank. The objective of qualitative control is to divert the flow of credit into particular uses or channels in the economy. Infact the objective of selective credit control is to encourage the flow of credit into those uses or channels which help the growth of economy. The following are the main types of selective credit controls exercised by the Central Bank. 1. Fixation of Margin Requirements on secured loans. 2. Regulation of Consumer Credit. 3. Control through Directives by Central Bank. 4. Rationing of Credit. 5. Moral Suasion. 6. Publicity.

7. Direct Action. All the above mentioned types of selective credit control are discussed as under. 1. Fixation of Margin Requirements: The margin is the difference between the loan value and the market value of securities offered by borrowers against secured loans. By prescribing the margin requirements on secured loans, the Central Bank does not permit the commercial banks to lend their customers the full value of the securities offered by them, but only a part of their market value. To start with, this method was applied to stocks and shares only. But now its scope has been extended to cover goods stored in authorized godowns. At present, this method is being extensively used by developing as well as developed countries to check the flow of credit into undesirable speculative activities. 2. Regulation of Consumer Credit: As we are aware that, durable consumer goods such as T.Vs, refrigerators, washing machines, motor vehicles etc are purchased in Western countries by the consumer on instalment credit. According to this system, a certain percentage of the price is paid by the consumers in downright cash. The remaining part of the price is financed by bank credit which is repayable by the consumer in instalments spread over a specified period of time. The objective of this method is to curb the consumption of durable consumer goods which happen to be in short supply in the economy. This method controls excessive consumer demand for durable goods. This method was first introduced by the Federal Reserve System in the U.S.A. in August 1941 to regulate the terms and conditions under which credit repayable in instalments could be extended to the consumers for purchasing durable goods. Later on the method of consumer credit regulation was adopted by Central Banks in other countries, such as those of Britain, Canada, Australia and New Zealand. 3. Control through Directions: Sometimes, selective credit controls may be enforced on the commercial banks through directives issued by the Central Bank from time to time. These directives may be in the form of written orders, appeals or warnings by the Central bank addressed to the commercial banks. These directives are issued to the commercial banks in order to realize the following objectives. i) To divert credit less urgent uses to more urgent uses. Or from less productive uses to more productive use. ii) To prohibit lending for certain purposes altogether. iii) To fix maximum limits of credit for certain purposes. The commercial banks generally decide by the directives issued to them by the Central Bank from time to time. These directives generally supplement the traditional weapons of control, such as, the bank rate and open market policy. 4. Rationing of Credit: This is another weapon in the armoury of the Central Bank. Rationing of credit as an instrument of credit control was first used by the Bank of England in the closing years of the eighteenth century. The term rationing of credit implies two things, first it means that the Central Bank fixes a limit upon its rediscounting facilities for any particular banks. Second it means that the Central Bank fixes the quota of every affiliated bank for financial accommodation from Central Bank. This method of rationing of credit has a historical background. Due to the operation of the usuary law, the Bank of England could not raise its rate of discount beyond maximum limit of 5 percent. It was not possible for the bank to discourage excessive borrowing from it by the banks during periods of monetary stringency. The Bank of England was thus compelled to ration credit among the member banks. But after the repeal of usuary law, the method of rationing of credit lost its importance in Britain. Central Banks in other countries such as Germany, France, and Mexico also make use of this method to check

excessive borrowing by the commercial banks from Central Bank. The rationing of credit as a method of credit control occupied a prominent place in Soviet Economic planning. 5. Moral Suasion: The moral suasion method is frequently employed by the Central Bank to exercise control on the commercial banks. This method involves advice, request and persuasion with commercial banks to cooperate with the Central Bank in implementing its credit policies. If the commercial banks do not abide by the advice or request of the Central Bank, no punitive action is taken against them. The Central Bank merely uses its moral influence with the commercial banks to prevail upon them to accept its policies. For example, the Central Bank may request the commercial banks not to extend credit for speculative purposes or it may request the member banks not to press with the demand for additional financial accommodation from it. The Central Bank under this method can only appeal to the patriotic and nationalistic sentiments of the commercial banks. The Central Bank may even hold occasional conferences with the commercial banks to make its policies known to them. Anyway, the method of moral suasion is a purely informal method with no legal sanction. The method of moral suasion has also its limitations. The main drawback of this method is that it lacks legal sanction. As such, it fails to be effective at a line when the forces of credit expansion in the economy happen to be very strong and powerful. Nevertheless, this method has its uses and can serve as useful supplement to other methods of credit control. 6. Publicity: Central Banks have adopted publicity as an instrument of credit control. They use this instrument not only for influencing the credit policies of commercial banks but also to educate and influence public opinion in the country. Infact publicity is an essential instrument to ensure the effectiveness of the monetary policy of The Central Bank. Under this method the Central Bank gives wide publicity to what is good and what is bad in credit system of the country. The Central Bank gives wide publicity to its thinking in the field of bank credit. The commercial banks, in their turn are guided by the ideas of the Central Bank in matters relating credit creation. Publicity as a method of credit control has been very extensively used in the U.S.A. when the Federal Reserve System regularly publishes reports regarding the credit creating activities of the member banks. The method is also widely used by the Central Bank in Germany and Sweden. The State Bank of Pakistan also periodically published returns and statements about the affairs of commercial banks. There is some controversy going on amongst the economists with regard to effectiveness of publicity as a method of credit control. While some economists feel that publicity is useful instrument of credit control, there are others who are of the opinion that it is at best only a minor instrument of credit policy. 7. Direct Action: The method of direct action is most extensively used by the Central Bank to implement their credit policies. This methods can be used to enforce both quantitative as well as qualitative credit controls by the Central Banks. This method is not used in isolation, it is used as a supplement to other methods of credit control. This method of direct action implies the use of coercive measures against those commercial banks whose credit policies do not confirm to the declared objectives of the Central Bank. This method also involves the issuing of general instructions by the Central Bank to all the commercial banks. It may also take the form of special instructions by the Central Bank issued to erring banks. It should however by remembered that the method of direct action is sued only as last resort when other methods fail to yield the desired result. The method of direct action can prove effective only when the Central Bank is armed with sufficient Legal powers to enforce its directives on the commercial banks. Hence the Central

Banks in several countries have been given statutory powers to take drastic action against the defaulting banks. According to recent Central Banking legislation, the Central Banks in different countries have been given extensive powers under the law to formulate the general credit policy to be followed by the commercial banks. They have also been authorized to prescribe rates of interest to be charged on different types of loans and adva