What is Monetary Policy?
The term monetary policy refers to actions taken by
central banks to affect monetary magnitudes or other
financial conditions.
Monetary Policy operates on monetary magnitudes or
variables such as money supply, interest rates and
availability of credit.
Monetary Policy ultimately operates through its influence
on expenditure flows in the economy.
Factors taken into account to determine
the level of money supply
1. The desired level of economic growth.
2. The desired level of government spending in relationship of this
with the government collection.
3. The level of credit with the requirements of the rest of the
economy to carry out normal activities.
4. The level of new money needed to meet the requirements of the
countrys international trade payments.
5. The velocity of money in circulation
Powers of monetary
authority to control money
supply
1. Exercise of fiat authority to issue paper
money.
2. Control banks reserve requirement
3. Use of discounting policy
4. Use of open market operation
5. Moral suation
Variable Reserve Ratio
Cash Reserve Ratio: the amount of cash
reserves the Banks have to maintain with the
Central Bank
Banks create credit on the basis of their cash
reserves.
The greater the excess reserves, the greater
the credit created.
Bank Rate or Discount
Rate
It is the rate of interest the central bank
charges its member banks.
By changing the discount rates, the central
bank controls the level of bank reserves and
the money supply.
Method: Discount rate affects bank interest
rates.
Open Market Operations
Buying and selling of government bonds or
securities by the Central Bank.
Increase Money supply =>
central bank purchases securities from open
market.
Decrease Money supply =>
central Bank sells securities.
Moral Suasion: involves advice, request
and persuasion with the commercial
banks to co-operate with the Central
Bank.
Characteristics of a
Central Bank
1. Publicly owned
2. Bank of currency and ultimate source of money.
3. As government bank, agent and adviser.
4. Bankers bank
5. Lender of last resort
6. Custodian of countrys reserve of foreign currency.
7. Regulation of monetary and financial activities.
financial system is the system that
allows the transfer of money between
savers (and investors) and borrowers.
Fiscal policy
One major function of the government is to stabilize the
economy (prevent unemployment or inflation)
Stabilization can be achieved in part by manipulating the
public budget-government spending and tax collections-to
increase output and employment or to reduce inflation.
FISCAL POLICY CHOICES
1. Expansionary fiscal policy: used to combat a
recession.
increase government spending and lower tax or
combination of the two.
2. Contractionary fiscal policy: used to combat
demand-pull inflation, due to excess spending.
Decrease in government spending and higher tax or
combination of the two.
Money is any object or record that is generally accepted
as payment for goods and services and repayment of debts in a
given socio-economic context or country
Medium of exchange
money is used to intermediate the exchange of goods and services, it is performing a function as
a medium of exchange.
Unit of account
A unit of account is a standard numerical unit of measurement of the market value of goods, services,
and other transactions. Also known as a "measure" or "standard" of relative.
Divisible into smaller units without loss of value; precious metals can be coined from bars, or melted
down into bars again.
Store of value
a money must be able to be reliably saved, stored, and retrieved and be predictably usable as a
medium of exchange when it is retrieved.
FUNCTIONS OF MONEY
Transactions motive. Money is a medium of exchange, and people
hold money to buy stuff. So as income rises, people have more
transactions and people will hold more money
Precautionary motive. People hold money for emergencies (cash
for a tow truck, savings for unexpected job loss).
Speculative motive. Money is also a way for people to store
wealth. Keynes assumed that people stored wealth with either money
or bonds.
THEOTIES ON THE DEMAND FOR MONEY
A commercial bank is a type of bank that provides services
such as accepting deposits, making business loans, and
offering basic investment products.
