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