Monetary policies are those policies usually exercised by the central bank on behalf of their government to control cost, quality, quantity and direction of credit in the economy. Monetary policies to a great extent can be said to be the management of expectations.
Monetary policy is the process by which the government, the central bank or the monetary authority in a country controls the supply of money, the cost or rate of interest and the availability of money in order to attain set objectives stirred towards the stability of the economy.
Monetary policies rest mainly on the relationship between the rate of interest in an economy and the total supply of money.
Instruments of Monetary Policy
The instruments used in monetary policies are divided into two groups;
Quantitative, General or Indirect Monetary Policy. Under this we have policies like bank rates regulations, Open market operations, Reserve requirements; these are meant to regulate the overall level of credit in the economy through commercial banks.
Qualitative, Selective or Direct Monetary policy. Here the policies used are aimed at controlling specific types of credits including changing margin requirements and regulations.
Open Market Operations; This is the sale and purchase of specific securities in the money market by the central bank. Through this commercial bank reserve reduce, reducing their lending power to individuals
Bank Rate; This is the minimum lending rate of the central bank at which it rediscounts first class bills of exchange and government securities held by commercial banks.
Change in Reserve Ratio; Here every commercial bank is required by law to keep a certain percentage of its total deposits in the form of a reserve fund in its vault and anther percentage with the central bank.
Selective Credit Control; This is use to influence specific types of credit for particular purposes. They usually take the form of changing margin requirements to control speculative activities within the economy and within specific industries.
Expansionary Monetary Policy: This can also be called an easy monetary policy; it is used to overcome recessions, depression or deflationary gap. When there is a fall in consumer demand for goods and services and in business a reduction in the demand for investment goods a deflationary gap emerges. The central bank starts an expansionary monetary policy that eases the credit market conditions, leading to upward shift in aggregate demand. For this to happen the central bank buys government securities in the open market. Lower reserve requirements, also lowers discount rate.
Restrictive Monetary Policy: This is a policy designed to curtail aggregate demand. It is used to overcome inflationary gap. The government starts a restrictive monetary policy to lower aggregate consumption and investment by raising reserve requirements, raising discount rates and also through selective measures.
LIMITATIONS TO MONETARY POLICY
· Increase in the velocity of money
· Commercial banks portfolio adjustments
· Discriminatory i.e. adverse effects on small business with higher risks and low capital base.
· Threat to credit market
· Alters expectations of borrowers and lenders
· Time logs
· Threatens solvency of Non-Banking Financial institutions/Intermediaries
ROLES OF MONETARY POLICY
· Controlling inflation pressure,
· Achievement of price stability.
· To bridge or correct adverse BOP deficit.
· Creation on Banking and Financial institutions.
· Interest rate policy i.e. increased incentive to save.
· Debt management.
· Exchange rate stability.
· Full employment