GOALS OF MONITORY POLICY

By: Tayyaub khalid

Primary goal
To control money supply

By Open market operations

Goals of monitory policy

There are 5 basic goals of monetary policy Stability in the price level (low inflation) High employment Economic growth Stability in the interest rate Stability in the exchange rate

Stability in the price level (low inflation)

Unstable prices slowdown the economic growth

make volatility in interest rates. It increase consumption of people or household Which effect saving of the people And make unequal distribution of wealth.

 Excessive demand in not the only reason of the

inflation The other reason is the economic shock/supply shock Like : in the supply of a crucial material, such as oil shock which effect almost every country of the world.

1. If monetary policy is tightened sharply By increase in the short term interest rate by a large amount The inflation rate will return to target (quickly) But economic development slowdown and create recession. 2. If monitory policy does not tighten so much Inflation rate will return to target more gradually But there will be a smaller slowdown in real GDP. First strategy is more effective for inflation target achievement but not on growth rate stability And second for the growth stability but not inflation

High employment
The second major goal for the fed.

People say Promote full employment but it is not

possible Reason: Frictional unemployment: Temporary unemployment of the people who seeks better jobs So the appropriate goal of the policymakers is actually a high level of employment. And 4% to 6% unemployment is considered as frictional unemployment .

Economic growth
The third goal of the fed is the increase in an

economys output of goods and services. Related with high employment Economy's appropriate rate of growth has to be substantial enough to generate high employment but low enough toward off inflation.

Stability in the interest rate

The goal of stabilizing interest rate is directly

related to the goals of growth and to the feds responsibility for the health of the nations financial and banking system. Note that the goal is to stabilize rate, not to prevent changes in rates.

Stability in the exchange rate

The goal of exchange rate stability is very important for international trade. high exchange rates like strong dollar, or currency having high value in terms of foreign currency, reduce demand for the domestic or US made products and increase the import of foreign goods. The result is a trade imbalance If the domestic currency is weak then it makes inflation as US buyers pay more for the many goods the do imports. For these reasons: The goal of stability in the currency market often amounts to keeping the value of the dollar in terms of the major foreign currencies. Within range that is considered politically acceptable and helpful to international trading, especially exporting.

Monetary Policy Tools:

Tools:
General Controls .

(Quantitative) Selective Controls. (Qualitative)

Quantitative :
Open market operations.

Reserve requirements.
Bank rate. Statuary liquid ratio.(SLR)

Repo rate.
Reverse repo rate.(RRR)

Qualitative:
Moral suasion.

Consumer credit control.

Direct action.

Open market operations:

Powerful tool of monetary policy.

Refers to the purchase and sale of securities by the

central bank of the country. Purchase/buy the government securities for expansion of credit.(to increase supply of money) Sale government securities for contradiction of credit.(to remove inflation ,to reduce supply of money)

Bank Rate:
Rate at which central bank gives loans to commercial bank. Tool used by central bank for short term purposes. Dear money policy: (To control inflation)

Bank rate ,lending /interest rate high ,borrowing is less profitable result, supply of money reduces in the economy. Example: If commercial bank borrow more so increase in supply of money. Near money policy: Bank rate decrease ,interest rate decreases, borrowing more profitable, supply of money increases result ,expansion of credit.

Reserve Requirement/Ratio/Capital:
Powerful weapon.

Has to keep some proportion of deposit with

central bank. By changing the ratio Central Bank controls supply of money. Increase in CRR will reduce available funds for banks for credit.(inflation reduced, supply of money decreases) Reduction in CRR will increase available funds for banks for credit.(supply of money increases)

Repo/Repurchase Rate.:
Rate at which commercial banks borrow funds from the central bank .

WHY ?
To meet the gap between the demand they are facing for money (loans) and how much they have on hand to lend.

In other words :
R ate at which the central bank lends shot-term money to the commercial

banks against securities, and at the same time commercial bank agreeing to repurchase them at a later date at a predetermined price.
Usually 15 days

Difference B/w Bank & Repo Rate:

Bank rate is a rate at which central bank lend

money to commercial banks. Repo rate is a rate at which commercial bank borrow from central bank. In case of repo rate commercial banks has to sell securities to central bank and borrow money where as in case of bank rate there is no sale of securities.

Reverse Repo Rate:

Rate which is paid/offer by central banks to

commercial banks on Deposit of funds with them. Or Rate at which central bank borrows from other banks. Used this tool when feels there is too much money floating in banking system . If commercial bank has a surplus fund then the deposit the funds with central bank and earn at Reverse repo rate . At higher RRR ,central bank borrow at high rate and commercial banks prefer to deposits their money with central bank.

Statuary liquid ratio:

Every bank is required to maintain at the close of

business every day, a minimum proportion of their Net Demand and Time Liabilities as liquid assets in the form of cash, gold . Determined and maintained by central bank in order to control the expansion of bank credit . Central bank increase this ratio up to 40%. An increase in SLR also restrict the banks leverage position to pump more money into the economy.

Moral Suasion.
Moral request by central bank to commercial

banks. Loans should not be given for un productive fields. Loans should not be given for speculative purposes.

Consumer credit control.

Applied during inflation.

If the central bank want to control the supply of

money the central bank direction to commercial banks. Loans should not be advanced for consumption purposes.

Direct Action:
A policy of central bank that against commercial

banks. Central bank will not advance loans to commercial banks for the sectors which creates inflation.