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What is Monetary Policy?

Monetary Authoritys policy to manage supply of money to achieve predetermined macroeconomic goals primarily Price Stability Policy affecting quantity of money which determines cost and availability of credit.

Objectives of monetary policy

Higher economic growth Higher rate of employement

Higher Economic Growth

Top priority in the economic agenda Level of economic growth determines fulfillment of social and economic need of people Only way to create job and eradicate poverty

Higher Rate of Employment

Congruent with economic growth objective Go Hand-in-Hand High employment is desired: Unemployment leads to lost output Full employment: All resources available in country are mobilized, National Income is maximum

Instruments of Monetary Policy

Quantitative Instruments Qualitative Instruments

Quantitative Instruments
Bank Rate/ Discount Rate:The interest rate at which a nation's central bank lends money to domestic banks. Often these loans are very short in duration.

Cash reserve ratio:The portion (expressed as a percent) of depositors' balances banks must have on hand as cash. This is a requirement determined by the country's central bank, which in the U.S. is the Federal Reserve. The reserve ratio affects the money supply in a country.

Qualitative Instruments
Credit Ceiling:Total amount somebody is allowed to borrow the highest amount that a lender will allow somebody to borrow, for example, on a credit card.

Change in Margin Lending:

The dollar amount available for withdrawal from an account with existing marginable positions being used as collateral.

Importance in Developing Countries

Development of Financial Institutions

Underdeveloped country: Lack of Financial Institutions People do not use Bank : All income goes to consumption No encouragement in Saving No Saving: No Investment Obstruction in economic growth

Monetization of Rural Sector

Underdeveloped countries: More people live to rural areas Transaction in barter system Monetary policy helps to remove barter system eg: Kale Damai

Development of Organized Money Market

Lack of organized money market: Money market controlled by big and rich money lenders Exploit general class Central Bank: Unorganized money market into organized. Appropriate interest rate.

Increase in Investment
Low income: High MPC, no saving No Saving : No Investment Monetary Policy: Proper environment for saving, Capital formation
Increasing interest rate (encourage saving) Loan at appropriate interest rate (encourage investment)

Appropriate BOP
Export <Import Export raw material, Import finished goods Monetary Policy: Encourages production of export goods providing subsidies

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