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the main objective of monetary policy is to stabalize the price level in the
economy.inflation and deflation are both nsuitable for the economy. if the price level is
fair and the adjustment between the price and cost exists, the rate of output can increases.
monetary policy is used to co ordinate the cost and price. so price stability is achieved
through the monetary policy.
the rate of exchange changes due to change in the import and export of commodities. the
rate of exchange can be controlled with the control of money supply and bank credit in
the country.
•if money supplt increases --> prices increases --> value of money decreases -->
export decrease
the expansion of bank credit leads to rise in prices, which reduces exports and increases
imports, in return an unfavourable balance of payment occurs. it is monetaru policy
through which the credit is controlled accordingly i.e. unfavourable BOP is removed by
contraction in bank credit.
•if money supply decreases --> inflation decreases --> prices decreases --> export
increases
the production and employment in the country is disturbed due to change in supply of
money. therefore supply of money is controlled for stability in production and
employment in the country.
•if money supply increases --> people have more money in their hand --> demand
for goods increases --> production increases --> employment increases
standardize living
it is also a major objective of monetary policy that it should improve the quality of life in
the country. for this purpose the central bank adopts a policy, which keeps the purchasing
power of the people at the desired level.
•if prices increases --> living standard poor --> purchasing power decreases
the anti cycle measures are adopted to remove fluctuations in the business cycle, which
can be possible with the full control on the supply of the money in the country. that is ,
during prosperity, when production, employment , prices and volume of credit increases,
it is necessary to contract the bank credit. whereas , during depression bnk credit is made
free to expand.
•in boom money supply decreases --> loans decreases --> demand decreases -->
prices decreases --> production decreases
•in depression money supply increases --> loans increases --> demand increases
--> prices increases --> production increases
the objective of monetary policy or credit control is to acheive full employment and
accelerated growth with stability in the economy without inflationary pressures and BOP
deficit.
economic development
•unprodutive sectors : consumer loans e.g loans for buying cars , house etc
the monetary policy ensures that the distribution of credit should be equitable and
purposeful. the credit priority should be given to backward areas.
deposits of gold
one of the objective of the monetary policy is to protect the deposits of gold from both
external and internal influences.
to increase the investment atmosphere, monetary policy gives incentives to both the
private and public sectors to invest their savings. in this way the country can achieve
economic stability.
•if money supply increases --> rate of interest decreases --> investment increases
•if money supply decreases --> rate of interest increases --> investment decreases
monetary policy is also adopted to control the sales and purchase of governmental
securities. in case of prosperity government securities are sold by central bank, which in
turn reduces the volume of credit. in the contrast, during depression thesee securities are
purchased by the central bank.
•to decrease money supply --> government sell securities --> people have less
money with them
•to increase money supply --> government purchase securities --> people will have
more money with them
quantitative controls
bank rate is the rate at which the central bank rediscounts the bill of exchange. we can
also say that it is the rate of interest at which central bank advances loans to the
commercial banks.if the central bank makes some changes in the bank rate, the rate
charged by commercial banks also alters that inturn affects the volume of loans.
•if bank reserve increases --> rate of interest increases --> loans decreases
•if central bank wants to increase money supplyin the economy --> decrease the bank
rate --> commercial banks borrowing increases from central bank -->
commercial bank lowers the interest rate --> borrowing by people increases -->
money supply increases
the sale and purchase of securities in open market (stock exchange) by central bank is
called open market operation.
•when central bank sells securities, the amount of cash with the people and the banks
is reduced . then with fewer amount of cash , the commercial bank can give fewer
loans.
•if central bank purchases securities, it means it is paying out cash. in return money
supply increases. when commercial bank sells securities to central bank, its cash
reserves increases. it is then in a position to expand credit.
the central bank, by changing the reserve requirment can control credit money. every
member bank keeps a percentage of its total deposits with the central bank.
•if the central bank desires to decrease the money supply, it raises the reserve ratio. in
this way, commercial banks are left with fewer amounts to lend.
•if the central bank feels that money supply is to be expanded, it lowers the reserve
requirment and raise the lending power of the commercial banks.
qualitative controls
regulation of margin
whenever the banks loans against security, it keeps a margin i.e. it gives small amount
against the value of the security. for example if aperson mortgage a property of one
million he will get a loan by bank of 75 lakh, then 25 lakh will be the margin requirment.
•when central bank wants to reduce money supply, it asks the member banks to
increase margin requirment. in this way amount of loans decreases.
if central bank wants to increase money supply, it asks member banks to decrease
margin requirment, in this way amount of loans increases.
central bank usually restricts consumer credit, so that more funds are available to the
industry, agriculture and other sectors
•if the central bank adopts a lenient policy about the consumer credit for the purchase
of consumer goods, the loans increases and the supply of money expands
credit rationing
sometimes the central bank fixes the limit upto which it loans to its member banks.
•if the central bank adopts expansionary monetary policy the rationing limit of loans
increases, then money supply increases.
•on the other hand if the central bank adopts a contractionary monetary policy the
rationing limit of loans decreases, then money supply decreases
advertisment
sometimes central bank publishes its policies and functions, using various media like TV,
radio and newspaper etc. this also helps to make other banks to realize the monetary
needs of the country.
direct action
central banks takes direct action against the commercial bank that refuses to act in
accordance with the policy of central bank. like refusal of rediscounting of bills or
declaring non-schedual bank etc
monetary policy can influence the level of national income very easily.
•during inflation a strict monetary policy consisting of increase in bank rate, increase
in reserve requirment and sale of governmebt securities can be adopted. all these
will have an effect on components of AD. Hence NI can be effected
If the equilibrium level of NI is above the full employment, the economy is facing
inflation. to remove inflation or infationary gap if central bank increases the bank rate,
commercial bank will also increase the rate of interest. as the result the concumer will
decrease the demand for consumer credit, investors will decrease the demand for
investment credit and government will decrease the demand for public loanss.
Accordingly, because of increase in rate of interest, AD curve will shift downward. this
will result in decrease in NI depending upon the value of rate of interest multiplier. as a
result inflation will be controlled as shown in figure.
Here basic equilibrium takes place at F which is supposed to be above full employment.
here the level of NI is AYF.Because of increase in rate of interest, AD curves shift
downward as C' + I' + G'. This intersects C + S + T at E.Accordingly level of NI
decreases to YF which is assumed to represent full employment.