Discover the Importance of Monetary Policy in the economy and how it influences various economic indicators.Monetary policy is the oldest policy for the economic stability. It is a policy which is adopted by the central bank of the country to control the supply of money.
Importance of Monetary Policy in Economics And For Counntry Economy.
Changes in bank rate policy:
The rate at which the central bank of the country gives loans to commercial banks is known as bank rate. By changing such rate of interest, the central bank can influence the supply of money in the country. To control inflation the central bank increases the rate of interest. To remove deflation central bank will decrease the bank rate.
Open Market Operation:
Under this technique, the central bank sells or purchases government securities. To remove the inflation, the ^entral bank sells the government securities To control the deflation, the central bank purchased the government securities.
Change in Reserve Requirements:
Each commercial bank has to keep a certain proportion of its deposits in the form of reserves just to meet the demands of the depositors The central bank can influence this reserve rate If the central bank realizes that the commercial banks are advancing excessive loans, it will increase the reserve requirement. In deflation if the central bank reduces the reserve requirements
Changes in Reserve Capital:
Each commercial bank has to keep a certain ratio of its deposits with central bank. To remove inflation the central bank will increase the reserve ratio. To remove deflation central bank will decrease the reserve ratio.
Changes in Marginal Requirements:
If there is inflation in the economy, the marginal requirements will increase. During deflation the marginalIf commercial banks are found advancing loans which create inflation, their activities will be unhealthy for whole economy. The central bank can black list such banks. Thus to avoide such bad reputation in future. They will be careful in advancing loans.
During inflation, a strict monetary policy consisting of increase in bank rate, increase in reserve requirements and sale of government securities can be adopted. All these will have an effect on the components of AD. Hence level of Nl can be affected, while during deflation, an easy monetary consisting of decrease in bank rate, decrease is reserve requirements and purchase of government securities can be adopted. All these will have the effect of increasing the AD and hence, the level of Nl can be raised. Amongst all the instruments of monetary policy, the changes in bank rate very much effective. Due to easy monetary policy, level of income increase, the transitive demand for money (Mtd) increased, This will have the effect of increasing the rate of interest.
The increased rate of interest may offset the expansionery effects of easy monetary policy. In such situations, if supply of money is increasing to each rising rate of interest, it may result in inflation. On the other side, whenever, due to tight monetary policy, level of income decrease, the transactive demand for interest. The decreased rate of interest may offset the effect of tight monetary policy. In such situation if supply of money is increased to check the falling rate of interest, it may result in deflation. All this shows that both the targets of interest and supply of money cannot be attained at the same time.