Monetary Policy: Definition, Objectives, Instruments, Types and Indicators

What is meant by monetary policy ? The definition of monetary policy is a policy issued by the Central Bank  to manage the money supply of a country in order to achieve certain goals, for example maintaining the stability of the currency value and increasing employment opportunities.

Another opinion states that the definition of monetary policy is the government’s efforts through the Central Bank to control the macro economy so that its condition is better by regulating the amount of money in circulation and improving the welfare of the people.

In Indonesia, this monetary policy is implemented through Bank Indonesia as the monetary authority to direct the national economy. In its implementation, monetary policy has a time lag that is relatively shorter than fiscal policy because Bank Indonesia does not need permission from the DPR and the cabinet in implementing monetary policy.

Also read: Fiscal Policy

Monetary Policy According to Experts

In order to better understand what monetary policy is , we can refer to the opinions of the following experts:

  1. Boediono

According to Boediono, the definition of monetary policy is the action of the government (Central Bank) to influence the macro situation, namely by balancing the money supply and the supply of goods so that inflation can be controlled, achieving full employment opportunities and smooth supply / distribution of goods.

  1. Perry Warjiyo

According to Perry Warjiyo, monetary policy is a policy of the monetary authority or central bank in the form of controlling monetary aggregates to achieve the development of economic activity which is carried out by considering the cycle of economic activity, the nature of a country’s economy, and other fundamental economic factors.

  1. Muana Nanga

According to Muana Nanga, monetary policy is a policy carried out by the monetary authority by controlling the money supply and interest rates to influence the level of aggregate demand and reduce instability in the economy.

  1. M. Natsir

According to M. Natsir, the definition of monetary policy is all actions or efforts of the central bank to influence the development of monetary variables (money supply, interest rates, credit interest rates, and exchange rates) to achieve the desired target.

Also read: Understanding Economics

Monetary Policy Objectives

As mentioned in the first paragraph, the main objective of this policy is to achieve a more stable macro economy. For example, increasing economic growth and equity, increasing employment opportunities, maintaining price stability, and maintaining balance of payments stability.

A more detailed explanation regarding the objectives of monetary policy is as follows:

  1. Circulating Rupiah currency as a medium of exchange for economic activities.
  2. Maintain stability between the needs of the economy and the price level.
  3. Optimizing liquidity distribution to increase economic growth in various sectors.
  4. Maintain economic stability by controlling the flow of goods and services (productivity).
  5. Maintaining the stability of prices in the market by controlling the inflation rate that occurs.
  6. Help increase employment opportunities by increasing investment so that new jobs open up.
  7. Maintain the stability of the Community Work Trade balance by increasing exports and reducing imports.

Read also: Principles of Economics

Monetary Policy Function

Monetary policies issued by the Central Bank have certain functions for the economy of a country. The following are some of the monetary policy functions:

  1. Serves to maintain the investment climate in a country.
  2. Serves to create many jobs.
  3. Help improve the stability of a country’s economic growth.
  4. Help improve the balance of payments.
  5. Maintaining the stability of currency exchange rates.
  6. Maintain a balance and keep the price of goods.
  7. Controlling the inflation rate in a country.

Also read: Definition of Inflation

Monetary Policy Instruments

In implementing monetary policy , the Central Bank makes use of various financial instruments. The instruments are as follows:

  1. Live Instruments
  • Determination of Interest Rates, which includes determination of the interest rate for deposits or interest rates on Bank loans by Bank Indonesia.
  • Determination of the Credit Ceiling, namely the provision of the maximum amount of credit that can be extended by banks.
  • Liquidity constellation, namely the obligation of commercial banks to maintain a certain currency in percent, to raise funds for financing the government budget.
  • Direct Credit, namely the obligation of Commercial Banks to provide credit to certain sectors.
  1. Indirect Instruments
  • Open Market Operations (OTP), namely the activity of buying and selling securities by the Central Bank and foreign currency in the foreign exchange market. OMO is conducted to influence interest rates, rupiah liquidity, inflation and exchange rates.
  • Discount Facility (DF), which is a monetary policy instrument that affects the circulation of money in the community through the determination of a Central Bank loan discount to Commercial Banks. The goal is to reduce demand for credit from banks and limit the circulation of money.
  • Reserve Requirement (RR), namely the obligation of Commercial Banks to deposit certain statutory reserves (RR) from Third Party Funds at the Central Bank, thereby affecting the ability of Commercial Banks to extend credit.

Also read:  Capital Market

Types and Indicators of  Monetary Policy

The monetary policy in effect in Indonesia can be divided into two types, as follows:

  1. Contractive Policy, namely a policy that limits the amount of money in circulation due to high inflation.
  2. Expansive Policy, namely policies that increase the money supply where the aim is to increase people’s purchasing power when the economy is in decline.

To determine the level of success of monetary policy, the Central Bank uses 3 indicators, namely;

  1. Money SupplyMonetary Targeting )
  2. Targeting ExchangeExchange Rate Targeting )
  3. Target InflationInflation Targeting )

The following is the explanation in the table:

Indicator Definition Advantages Deficiency
Money Supply ( Monetary Targeting ) Determine the growth in the amount of money circulating in society as an intermediate target It is possible to implement an independent monetary policy so that the central bank can focus on controlling inflation > Its application depends on the stability of the relationship between monetary quantities and the final target (inflation).

> Difficult to understand by ordinary people.

Targeting Exchange ( Exchange Rate Targeting ) Set and adjust the value of the domestic currency against the currencies of major countries that have low inflation rates. > Can reduce the rate of inflation.

> Simple and easy for the public to understand.

> Targeting of exchange rates is defined by the rules that discipline monetary policy

> Vulnerable to speculators’ actions.

> The turmoil that occurs in a country can directly impact the domestic economy

Target Inflation ( Inflation Targeting ) Setting a medium-term inflation target and commitment to achieving price stability are long-term goals. > Simple and very clear achievement targets.

> Does not depend on the stability of the relationship between monetary quantities and the final target (inflation).

> Increase central bank accountability

> Monetary policy can be focused on achieving stability in the domestic economy

The signal to target achievement is not as fast as the previous approach

Also read: Macroeconomics

Example of  Monetary Policy

The following are some examples of monetary policies that have been carried out in Indonesia:

  1. Bank Indonesia (BI) conducts an auction of its certificates, or it can also buy securities on the capital market
  2. BI can lower interest rates when economic conditions match expectations. And vice versa, BI can raise interest rates when it wants to limit economic activity so that money circulation is reduced.
  3. When the economy goes into a recession, the circulation of money will be increased so that economic activity will increase. One example is buying securities.
  4. When inflation occurs, BI can reduce the circulation of money in the community by selling securities so as to reduce excessive economic activity.

Also read: The Perfect Competition Market

This is a brief explanation of the meaning of monetary policy, its objectives, instruments, types and indicators. Hopefully this article is useful and adds to your insight.


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