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x Student Name : Hajara Saleeth (CB003287) x Intake : DF08A2BA
x Module Code : ABUS018-3-2 x Lecturer : Ms. Sankapali Gunawardana
Submission Date :
August 31, 2009
Asia Pacific Institute of Information Technology, Sri Lanka
................10 References««...7 What were the Results? ..................................................................................................................................««««««««««««««««««««««13 2 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY ............................................................................««««««««««««.................................................... 3 Introduction ................««««««««««««««««««............. 4 Economic Arguments«««««......................................................................................................«««««««««5 What are the Monetary Policy Steps Taken by Central Bank of Sri Lanka to Achieve Macro Economic Objectives during Last 05 Year?.....................MACRO ECONOMICS INDIVIDUAL ASSIGNMENT Table of Contents Acknowledgement ..................................................
I like to thank my dear family for their valuable advice and as help given to me at all times. all my efforts could have been useless. Last but not least we thank my friends at APIIT for always giving me a helping hand. 3 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY . Without her guidance. I would like to thank the non-academic staff of Asia Pacific Institute of Information Technology for helping me with various issues during the project. Sankapali Gunawardana for the guidance and assistance provided.MACRO ECONOMICS INDIVIDUAL ASSIGNMENT Acknowledgement I would like to thank our Macro Economics lecturer Ms.
adjusting reserve requirements and etc. the money supply and ultimately price inflation. inflation. And also they act as the advisor for the government in designing and adopting the monetary policy. 4 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY . open market operations.´ (Anon. Low unemployment 04.MACRO ECONOMICS INDIVIDUAL ASSIGNMENT Introduction Any economy in the world tries to achieve certain goals which are called macroeconomic variables/goals. 2009) Central bank interferes in deciding lending rates and they control the money supply of the market by conducting open market operations and imposing certain reserve requirements for commercial bank. By doing so. government influences the aggregate demand. Achieving economic growth 02. money supply. Throughout this report I am going to analyze how does the Central bank of Sri Lanka has contributed towards achieving macroeconomic goals during last 05 years using monetary policy tools. Avoiding heavy fluctuations in exchange rates These goals are contradicting with each other and economy has to maintain a healthy balance between these variable for their survival. exchange rates and balance of payment. unemployment. These goals are interrelated and they try maintaining good balance between those goals. Maintaining low inflation 03. Macroeconomic goals are 01. 2009) Government exercises monitory policy through activities of central bank by influencing interest rates. ³Monetary Policy involves changes in the base rate of interest to influence the rate of growth of aggregate demand.´ (FXA Securities Ltd. Avoid negative balance of payments 05. Central bank is defined as ³a bank which is responsible for controlling a countries monetary policy.
This will reduce the money supply and inflation. Reduction in inflation makes exports cheaper and imports expensive which will help to maintain balance of payment equilibrium as imports will be less than the exports. And also when foreign investments are attracted there will be capital inflow and this will lead to a favorable balance of payment. If the government buys back the issued security it will have opposite consequences to what is mentioned above. Ways in which that the central bank exercise their influences are called monetary policy tools. If the interest rates were set low it will have opposite consequences to what is mentioned above. foreign investors will be attracted to invest their money in local banks. such as Treasury Bills or Government bonds. reduce economic growth due to fewer investments in the economy and increase unemployment. 2009) This means central bank issues securities in order to reduce the money supply in the market and thereby reduce aggregate demand.MACRO ECONOMICS INDIVIDUAL ASSIGNMENT Economic Arguments The central bank can influence macroeconomic goals in many ways. When interest rates on deposits are made relatively higher than the other countries. a tool of monetary policy. On the other hand reducing aggregate demand and inflation can lead to increase in unemployment levels. y Adjusting the reserve requirements- ³Reserve requirements. y Deciding the interest rates on savings- If the interest rates are set high it will lead to increase in the savings and thereby reducing the consumption and reduce the aggregate demand. There are many monetary policy tools such as: y Open market operations- ³Open Market Operations involve the purchase or sale of securities. This will create demand for domestic currency and as a result value of the domestic currency will appreciate.´(Federal Reserve Bank of New York. price levels and inflation. When the reserve percentage is 5 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY . 2009) This means the central bank order commercial banks to keep a certain percentage of their deposits by customers with Central bank. are computed as percentages of deposits that banks must hold as vault cash or on deposit at a Federal Reserve Bank. by the Central Bank in order to influence the money supply´ (Central Bank of the Bahamas.
If the bank reduces the reserve percentages it will lead have opposite have opposite consequences to what is mentioned above. commercial banks would prefer to deposit money with central bank rather than lending money to general public. inflation and economic growth. This would reduce the amount of landings and thereby reduce the consumption. If the interest rates on deposits are set low it will have opposite consequences to what is mentioned above 6 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY . y Adjusting the interest rate paid on cash reserves - Commercial banks hold certain amount of deposits with central bank and central banks pays an interest/return for the deposits made. This will also result increase in unemployment. From time to central bank changes the interest rate paid on these deposits to alter the money supply.MACRO ECONOMICS INDIVIDUAL ASSIGNMENT increased it reduces the bank¶s ability to lend and this will reduce the consumption and thereby reduce the aggregate demand. When the interest rate on deposits are made higher than the normal lending rates of commercial banks. aggregate demand and inflation. But this can increase the unemployment level and the economic growth.
2008.MACRO ECONOMICS INDIVIDUAL ASSIGNMENT What are the Monetary Policy Steps Taken by Central Bank of Sri Lanka to Achieve Macro Economic Objectives during Last 05 Year? During last 05 years in general the central bank has adopted a tight monetary policy to reduce the inflation caused by rising global food prices. Intervention to avoid depreciation of Rupee value³Pressure in the foreign exchange market warranted Central Bank intervention in the foreign exchange market through supplies of foreign exchange to prevent a sharp depreciation of the exchange rate´ (Central Bank of Sri Lanka.151) When the there was an out flow of foreign currency due to the withdrawals by foreigners due to financial crisis. p. Open market operations (OMP) During this 05 year period in general central bank has carried out OMP to reduce money supply by selling treasury bills and bond to reduce the money supply and thereby reduce the inflation. 2008 chapter 7 ) 02.´Treasury bills amounting to Rs. Those activities are: 01.´ (This has lead to a demand for rupee which resulted in an appreciation of the rupee and has helped to achieve balance of payment equilibrium by a capital inflow.26. 03. This has helped achieving the objective of maintaining healthy exchange rate.6 billion was sold outright to absorb excess liquidity on a permanent basis´ (Central Bank of Sri Lanka. 7 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY . central bank supplied foreign currencies from their reserves to the market to avoid the rupee value getting depreciated. Allowing foreign investors to invest in government securities³The government permitted foreigners to invest up to a maximum of 10 per cent of the value Of outstanding Treasury bills effective from May 2008.
2005 and 2006 were relatively low. 2006 lending rates were relatively low and during 2007 and 2008 lending rates have increased to 17. So that there will be reduction in money supply and aggregate demand and it has resulted in lowering the inflation to a single digit by middle of 2009. consumption.95% and 18. Increasing lending ratesDuring 2004.157) This is due to the tightening monetary policy exercised by the central bank to reduce lending. Table 1 above shows relevant data over the given period of time. 2005.5% respectively. 8 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY . Table 1 below shows relevant data over the given period of time. p. By increasing the savings rate savings are made attractive and consumptions are discouraged.(Central Bank of Sri Lanka.MACRO ECONOMICS INDIVIDUAL ASSIGNMENT 04. Increasing the deposit/ savings rateThe interest rates on fixed deposits in commercial banks were made low during 2004. and aggregate demand and there by reduce inflation rate which was sky high during 2008. Table 1.25% respectively. ³The Central Bank tightening its monetary policy stance resulted in higher borrowing costs´ (Central Bank of Sri Lanka. 2008) 05. During 2007 and 2008 interests on fixed deposits have risen to 20% and 20. 2008.
p.152) 9 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY .7 billion. The actual increase in currency in circulation however. ³The decline in deposits of commercial banks with the Central Bank was due to the reduction of the SRR by 225 basis points.12. 2008. was only around Rs.MACRO ECONOMICS INDIVIDUAL ASSIGNMENT Even though central bank was focusing on reducing money supply and aggregate demand to reduce inflation.´ (Central Bank of Sri Lanka. in order to strike a balance between reducing unemployment and achieving economic growth. y Reduction in SRR (Statutory Reserve Requirements) This is where the central bank reduces the reserve requirement on commercial bank and thereby allowing them to lend more which ultimately increases money supply and aggregate demand. they sometimes had to expand the money supply by using expansionary monetary policy tools. These were done with intention of achieving economic growth and reducing unemployment.
85) Due to the tight monetary policy adopted central bank was able to control the rate of raising the inflation when the food prices in the global market were rising at higher level.(Central Bank of Sri Lanka.(Central Bank of Sri Lanka. 2008. By mid 2009 they were able to bring down the inflation rate to a single digit even though commodity prices were rising in the global market. y Reducing the inflation- Graph 1. p. ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY 10 .MACRO ECONOMICS INDIVIDUAL ASSIGNMENT What were the Results? y Achieving economic growth- Table 2. This shows that monetary policy adopted by central bank was effective. 2008) Table 2 show that there is an upward trend in economic growth over the period of time even though there is a slight decline in year 2008 due the global financial crisis.
11 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY . p.(Central Bank of Sri Lanka.157) This graph clear shows unemployment rate is reducing over the given period of time and it suggests that monetary policy was effective.MACRO ECONOMICS INDIVIDUAL ASSIGNMENT y Reduction in unemployment- Graph 2. 2008.
p.(Central Bank of Sri Lanka. 12 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY . y Maintaining exchange rate stability- Due to the tight monetary policy they were able to maintain the healthy level of exchange rate stability over the given period of time without letting the value of rupee getting depreciated even during the financial crisis. 2008.7) The overall BOP was positive over the period of time even though it was negative in 2008 due to unexpected capital outflow due to the financial crisis which concludes that the monetary policy was effective.MACRO ECONOMICS INDIVIDUAL ASSIGNMENT y Achieving BOP equilibrium- Graph 3.
2008. [Accessed on: 30 August 2009] y FXA Securities Ltd. 2009 .html . Annual Report-2008. FXA Securities Ltd. 2008. Annual Report-2008. 2009. 2008. 2008. ³Monetary Policy´.htm .com/monpol.Central Bank of Sri Lanka. Colombo-Sri Lanka 13 ASIA PACIFIC INSTITUTE OF INFORMATION TECHNOLOGY .Central Bank of Sri Lanka. Colombo-Sri Lanka y Table 02. Colombo-Sri Lanka y Graph 03. Colombo-Sri Lanka y Graph 02. 2009. [Accessed on: 30 August 2009] y Central Bank of Sri Lanka. ³Reserve Requirements. Colombo-Sri Lanka y Central Bank of the Bahamas. [online].Federal Reserve Bank of New York´. Available: http://www. Open Market Operations.Fed points. [online]. Available: http://www. 2009.html . Colombo-Sri Lanka y Table 01. [Accessed on: 30 August 2009] y Federal Reserve Bank of New York.Central Bank of Sri Lanka. [online].MACRO ECONOMICS INDIVIDUAL ASSIGNMENT References y Anon.centralbankbahamas. 2008. Annual Report-2008. glossary . Annual Report-key economic indicators-2008.org/aboutthefed/fedpoint/fed45.newyorkfed.Market. Annual Report-2008. [Accessed on: 30 August 2009] y Graph 01. [online]. Annual Report-key economic indicators-2008.Central Bank of Sri Lanka. Available: http://www.finpipe.com/market_operations.Central Bank of the Bahamas . 2008.Central Bank of Sri Lanka.fxasec. Available: http://www.com/ehtml/glossary.php .