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Transcript
Monetary Policy ► Monetary policy may be defined as “that branch of economic policy which is concerned with the regulation of the availability (or supply), the costs and the directions of credit”. It is effected by various techniques (methods) in the hands of the central bank. Objective of MP ► The objective of credit control or monetary policy have been different at different times in different countries according to the economic situations and problems faced by them. Objective of MP ► Before World War 1 (1914), the maintenance of the exchange rate stability was the main objective and after this War the control of inflation become more important. Objective of MP ► During the Great Depression (1929-34) the control of deflation/depression assumed more significance. ► In World War II (1939) full employment began to be given the greatest importance. After World War II the emphasis was full-employment without inflation. Objective of MP ► In the modern times economic development with monetary stability is accepted as the most important goal of credit control. ► The main objective of this credit control function is to save the economy from inflation and deflation and to stabilize the economy and prices. Instruments of Monetary policy ► Quantitative ► Qualitative Quantitative ► Bank rate policy/ official rate policy. ► Open market operation. ► Variable reserve ratio ► Credit rationing Bank rate policy/ official rate policy. ► Rate of interest at which the central bank grant credit to other banks. ► When bank rate is raised, other bank’s interest/return rates on advances also move up. ( Monetary expansion decrease) ► When bank rate is decreased other bank’s interest rate/return rates on advances also go down. ( Monetary expansion increase) Open Market Operation ► Buying and selling of government securities by the central bank with a view to influencing money supply is called open market operation. Open Market Operation ► When central bank sells securities to buyers make payment for these to the central bank. As result the lending and financing power of banks decreases which leads to reduction in the rate of credit expansion. Variable Reserve Ratios ► The amount of money which the banks are legally required to keep with the central bank is termed legal cash reserve ratio or requirement. It is certain percentage of deposit. Liquidity Ratios ► In Pakistan liquidity ratio refers to the amount of assets which banks are legally required to hold in the forms of ► Cash in hand ► Balances with SBP/NBP ► Approved Securities. Qualitive ► Moral Suasion By virtue of its special position, the central bank can persuade commercial banks to follow a specific credit policy. In this connection the central bank employ oral or written appeals or warnings. Publicity Channels of monetary policy ► A central bank derives the power to determine a specific interest rate in the wholesale money markets from the fact that it is the monopoly supplier of ‘highpowered’ money, which is also known as ‘base money’. ► Bank chooses the price at which it will lend highpowered money to private sector institutions. ► The quantitative effect of a change in the official rate on other interest rates, and on financial markets in general, will depend on the extent to which the policy change was anticipated and how the change affects expectations of future policy. ► ► An increase in the money supply lowers the real interest rate, which in turn stimulates investment and therefore GDP. Asset prices ► Changes in the official rate also affect the market value of securities, such as bonds and equities. The price of bonds is inversely related to the long-term interest rate, so a rise in long-term interest rates lowers bond prices. The exchange rate ► Policy-induced changes in interest rates can also affect the exchange rate. The exchange rate is the relative price of domestic and foreign money, so it depends on both domestic and foreign monetary conditions. ► However, other things being equal, an unexpected rise in the official rate will probably lead to an immediate appreciation of the domestic currency in foreign exchange markets. ► The exchange rate appreciation follows from the fact that higher domestic interest rates, relative to interest rates on equivalent foreign-currency assets, make sterling assets more attractive to international investors. ► The exchange rate should move to a level where investors expect a future depreciation just large enough to make them indifferent between holding sterling and foreign-currency assets. Expectations and confidence ► Official rate changes can influence expectations about the future course of real activity in the economy, and the confidence with which those expectations are held. ► Such changes in perception will affect participants in financial markets, and they may also affect other parts of the economy via, for example, changes in expected future labour income, unemployment, sales and profits. Fiscal Policy ► It refers to adjustment in government revenue and expenditure to attain various macro economic goals, e.g. ► Full employment ► Economic stability ► Economic development