Economics - Monetary Policy - Notes - Economics, Study notes of Economics

Download Economics - Monetary Policy - Notes - Economics and more Study notes Economics in PDF only on Docsity! MONETARY POLICY Introduction Monetary policy plays a vital role in shaping the economy of a country because money and credit influence tremendously the course, nature and volume of economic activities. A keenly and appropriately weaved monetary policy can significantly aid economic growth by adjusting the money supply according to the needs of economic growth by directing the flow of funds into desired channels. Apart from that, monetary policy can make available the institutional credit to the much desired and required economic pursuit more appropriately, in the present day management of the economy, monetary policy plays an extremely important role of stabilizing the economy. Meaning of the Monetary Policy Monetary policy is an important tool in the hands of the monetary authority (more often central bank of the country) to regulate the flow of money in the economy according to needs at a particular point of time. Through this tool, the monetary authority achieves many macro economic goals. The need for monetary policy is felt because money can’t manage itself. Monetary management itself therefore, the main issue of monetary policy. According to Prof.Wrightsman, the deliberate effort by the central bank to control the money supply and credit condition for the purpose of achieving certain broad economic objectives. (something needs to be added, sentence incomplete) In the Indian context, monetary policy comprises those decisions of the government and the Reserve Bank of India which directly influence the volume and composition of money supply, the size and distribution of credit, the level and structure of interest rates, and the direct and indirect effects of these monetary variables upon related factors such as savings and investment and determination of output, income and price. Monetary policy is only a means to an end and not an end in itself. Monetary policy has to be structured and operated within the institutional framework of the money market of the country. Credit control measures and decisions are the constituent elements of a monetary policy. In a developing economy there are two factors of monetary policy- Positive and Negative. In its positive aspect, it sets out the promotional role of central banking in improving the savings ratio and expanding credit for facilitating capital formation. In its negative approach, it implies a regulatory phase of restricting credit expansion, and its allocation according to the absorbing capacity of the economy. 1. Neutrality of Money According to some economists like Wicks Steed, Hayek and Robertson the best monetary system is one in which money is neutral. Money should be a passive factor. It should not be allowed to interfere with economic forces like productive efficiency, real cost of production and consumer preferences. Therefore, according to them money should facilitate exchange alone. The quantity of money should be controlled in such a way that the total output, the total transactions and prices of goods and services being exactly what they would be in an efficient barter economy. It implies that the monetary authority must keep the quantity of money perfectly stable. The neutral money concept has been criticized severely by many economists as follows: In fact a mild inflation of the magnitude of 2 to 3 percent is suggested for the smooth growth and economic development of an economic. 3.Full Employment Most economists considered attainment of full employment as for most and ideal objective of monetary policy after the publication of “General Theory” of Keynes. Thus, the use of monetary policy for promoting full employment is of recent origin. Many modern economists are of the view that, economic stabilization can be combined with the objective of having a full level of employment. By encouraging saving and investment, monetary policy can play an effective role in realizing its objective of full employment. Many modern economists feel that the proper aim of a monetary policy is neither price stability nor neutrality of money, but optimum utilization of resource full employment level. 4. Monetary Policy and Economic Growth Economic growth is undoubtedly the primary goal of any country. Therefore, monetary policy is taken into help for achieving this goal. Though, till recently many economists considered monetary policy as a short term policy primarily aimed at full employment and mitigating cyclical fluctuations and not concerned with economic growth .However, recreantly it has been realized by the economists and the managers of the economy that mere achieving full employment is not enough but the economy should aim at achieving continuous and faster economic growth for providing a high standard of living to the people. Some economists like Howard Ellis, are strongly opposed of the idea of the role monetary policy is economic growth because they fear inflation. Still there are economists like Whittlesey, who strongly support the role of monetary policy in economic growth and argue that since economic growth is the primary aim of the general economic policy which is a part of the general economic policy, there is no reason why monetary policy should not be directed to achieve this objective. Monetary policy can contribute to the achievement of economic growth in two ways- Management of aggregate demand and Encouragement to saving and investment Let us explain the above two points:- Management of Aggregate Demand It is expected from the monetary authority to keep the aggregate demand for money in balance with the aggregate supply of goods and services. For this, a flexible monetary policy is required. A tight or dear restrictive money policy will have to be applied when there is excess demand on the economy threatening to raise prices and create conditions of unsustainable boom. Contrary to that are expansionary or cheep credit policy has to be followed when there deficiency a of aggregate demand and supply is in excess casing a fall in prices, production, employment and income. It is argued that a tight money policy impedes while an easy money policy promotes economic growth. But both are extremist views where as the truth lies in the mid way. A tight money policy is not conductive to growth when it is applied at a wrong time. In a situation when demand is deficient and resources are unemployed, an easy money policy is most suitable. But if it is carried beyond the limit, it will generate inflationary pressure and to control it. A tight money policy would be need. Therefore, a flexible monetary policy has been advocated to achieve economic growth with price stability. Precisely, monetary policy can assist in promoting economic growth by maintaining reasonable price stability and optimum use of economic resources in an economy. 1. Encouragement to Saving and Investment Monetary authority can help economic development by creating a favorable environment for saving and investment which is the back bone of the