Macro stabilizing polices

Unit 12
 1. Monetary policy
• Monetary policy is basically concerned with the monetary system of the
country.
• Monetary policy is the macroeconomic policy undertaken by the central
bank to achieve the predetermined objectives through the change in
money supply, credit and interest rate in the economy.
• It aims at influencing economic activity in the economy mainly through
two major variables
1. Money supply
2. Rate of interest
• The central bank of a country is the traditional agent which formulates
and operates monetary policy in a country
• Nepal Restra Bank as it is obvious carries out monetary policy in Nepal.
 Instruments of monetary policy
1. Qualitative / indirect instruments:
• They affect the level of aggregate demand
through the supply of money, cost of money
and availability of money.
• They are meant to regulate the overall level
of credit in the economy through bank and
financial institutions.
 a. Cash reserve ratio (CRR):

• It is the percentage of total deposit which commercial

banks are required to maintain in the form of cash
reserve in the central bank.
• It is the legal liability of commercial banks to be
maintained at central bank against their deposits.
• It not only influences volume of excess reserve with
commercial banks but also the credit multiplier of the
banking system.
• If this this ratio is increased, less money is left for credit
creation or decrease money supply and vice versa
 b. Bank rate
• When commercial banks faced the shortage of cash
reserve, they borrow the money from central bank for
short term at certain rate of interest rate.
• Bank rate is the rate at which central bank lends
money to the commercial banks and rediscounts the
bills of exchange presented by the commercial banks.
• A rise in bank rate reduces the commercial banks’
capacity to borrow from the central bank thereby
reducing money supply in the economy and vice versa
 c. Open market operations
• It refers to the purchase and sale of securities by the
central bank in the market.
• When central bank decides to reduce money supply in
circulation, it sells government securities to
commercial banks.
• When the central bank decides to pump money into
circulation, it buys back the government securities.
• Monetary instruments used in open market
instruments are outright purchase auction, outright
sale auction and reverse repo auction.
2. qualitative/selective/direct instruments

a. Regulation of margin requirement:

• The commercial banks provides loans to their customers
against some tangible collateral.
• The difference between the value of collateral and the
amount of loan provided by commercial bank is called
margin requirement.
• If the margin requirement fixed by central bank is 40%, the
customer can borrow from commercial bank up to the
value of 60% of collateral
• The increase in margin requirement decreases the
availability of credit and vice versa.
 b. Regulation of consumer credit
• This instrument is used to check the excessive demand
and control prices of consumer durables
• Under this instrument, a certain percentage of
consumer durable good is paid by the consumer cash.
The balance is financed through the bank credit which
is repayable by the consumer in installment
• The central bank controls the consumer credit by
changing the borrowing amount for the purchases of
the consumer durables and the period over which the
installment can be extended.
 c. Rationing of credit
• This instrument is used to control credit
provided by the commercial banks
• The central bank may fix the limit of maximum
loans and advances to the commercial banks.
 Cont…………
d. Direct action
e. Moral suasion: advising, requesting and
persuading the commercial banks to
cooperate with the central bank in
implementing its general monetary policy.
f. publicity
 Types of monetary policy
1. contractionary monetary policy: a monetary
policy designed to curtail aggregate demand
is called contractionary monetary policy.
2. expansionary monetary policy: a monetary
policy designed to increase aggregate
demand is called expanionary monetary
policy.
 Cont…………….
Small Bank Money:
• Monetary policy is also not successful in such countries
because bank money comprises a small proportion of the
total money supply in the country. As a result, the central
bank is not in a position to control credit effectively.
Money not deposited with Banks:
• The well-to-do people do not deposit money with banks
but use it in buying jeweler, gold, real estate, in
speculation, in conspicuous consumption, etc. Such
activities encourage inflationary pressures because they lie
outside the control of the monetary authority.
 Cont………………
High Liquidity:
• The majority of commercial banks possess high liquidity so
that they are not influenced by the credit policy of the
central bank. This also makes monetary policy less
effective.
Large Number of NBFLs:
Non-bank financial intermediaries like the indigenous
bankers operate on a large scale in such countries but they
are not under the control of the monetary authority. The
factor limits the effectiveness of monetary policy in such
countries.
 Fiscal policy
• Fiscal policy is a policy concerning the receipts
and expenditures of the government.
• The fiscal policy is the policy for the
government revenue, expenditure and
borrowing to meet the goals targeted by the
government.
• Fiscal policy has become more popular
measures after the depression of 1930’s.
 Types of fiscal policy
1. Expansionary fiscal policy: the fiscal policy
which increases aggregate demand by
increasing government expenditure or lowering
taxes is called expansionary fiscal policy.
2. Contractionary fiscal policy: the fiscal policy
which decreases aggregate demand by
increasing government expenditure or
increasing taxes is called contractionary fiscal
policy.
 Cont……………
2. Economic growth:
• Economic growth can be achieved by efficient
utilization of resources through taxation, public
savings and private savings.
3. Price stability: control of inflation and deflation
4. Efficient mobilization of resources: encourage
production of desirable goods and discourage those
goods which are socially undesirable through shifting
resources from unproductive activities to productive
activities.
 Cont……………
5. Reduction in inequalities of income and
wealth:
6. Balance regional development
7. Capital formation
8. Development of infrastructures
9. Economic stability
10. Reducing the deficit in the balance of
payments
 Instruments of fiscal policy
1. budget: balanced, surplus and deficit
2. Taxation
3. Government expenditure
4. Public borrowing
5. Public works