Monetary Policy definition economics - Economicstool

Here we will learn about the monetary policy definition economics also we will know about the
Expansionary Monetary Policy, Tools for monetary policy and monetary policy objectives.

Monetary Policy definition economics

Monetary policy refers to the credit control measures adopted by the central bank of a country, Johnson defines Monetary policy "as policy employing Central bank's control of the supply of money as an instrument for achieving the objectives of general economic policy."

monetary policy definition economics

G.K. Shaw defines it as "any conscious action undertaken by the monetary authorities to change the quantity, availability or cost of money."

Expansionary Monetary Policy

An expansionary monetary policy is used to overcome a recession or a depression or deflationary gap. When there is full in consumer demand for goods and services, and in business demand for investment goods and deflationary gap emerges. The central bank starts an expansionary  monetary policy that eases the credit market conditions and leads to an upward shift in aggregate demand. For this purpose, the central bank purchase government security in the open market, lowers the reserve requirements of members banks, lowers the discount rate and encourage consumer and business credit measures. By such measures, it decreases the cost and availability of credit in the money market, and improve the economy.

monetary policy objectives
The expansionary monetary policy is explained in terms of figure A and B where the initial reception equilibrium is at R, Y, P and Q . At the interest rate R in panel  A of the figure, there is already an excess money supply in the economy. Suppose the central bank credit policy result in an increase in the money supply in the economy. This leads to a rightwards shifts of the LM curve to LM¡. This increase income from OY to OY¡ and aggregate demand expands and the demand curve D shifts upward to D¡ in panel B.  With the increase in the demand for goods and services, output increases from OQ to OQ¡ at a higher price level P¡. If the expansionary monetary policy operates smoothly, the equilibrium at E¡ can be at the full equilibrium level.

Monetary Policy Objectives

Following are the objectives of monetary policy.

Full employment:- 

Full employment has been ranked among the foremost objectives of monetary polity. It is an important objective not only because unemployment leads to wastage of potential output, but also because of the loss of social standing and self respect. Moreover, it beats poverty.

Price stability:- 

One of the policy objectives of  monetary policy is to establish the price level. Both economist and laymen forever this policy because fluctuations in price bring uncertainty and instability to the economy. Rising and falling prices are both bad because they bring unnecessary loss to some undue advantages to others.

Economic growth:- 

One of the most important objectives of monetary policy in recent year has been the rapid economic growth of an economy. Economic growth is defined as "the process whereby the real and per capita income of a country increases over a long period of time". In its wider aspect, economic growth implies rising the standard of living of the people and reducing inequalities in income disparity distribution.

Tools for Monetary Policy

The Instrument of monetary policy are two types: first, quantitative, General or indirect; and second, qualitative , selective or direct. They affect the level of aggregate demand through the supply of money, cost of money and availability of credit. 

Bank Rate Policy:- 

Bank rate is the minimum lending rate of the central bank at which it re discounts first class bills of exchange and government securities held by the commercial bank. When the central bank find that inflationary pressure have started emerging with in the economy, it rises the bank rate.

Open market operations:- 

Open market operations refer to sale and purchase of securities in the money market by the central bank. When pries are rising and there is need of control them, the central bank sells the securities. 

Changes in reserve ratios:- 

This weapon was suggested by Keynes in his Treatise on money and USA was the first to adopt it as a monetary device. Every bank is required by law to keep a certain percentage of its total deposits in the form of a reserve fund in its vaults and also a certain percentage with the central bank.

Selective Credit Controls:- 

Selective credit controls are used to influence specific type of credit from particular purposes. They usually take the form of changing margin requirements to control speculative activities within the economy.
For an effective anti cyclical monetary policy, bank rate, open market operations ,Reserve ratios and selective control measures are required to be adopted simultaneously. But it has been accepted by all monetary theory that (i) the success of monetary policy is Nil in a depression when business confidence is at its lowest ebb and (ii) it is successful against inflation. The monetarists contend that as against fiscal policy, monetary policy possesses greater flexibility and it can be implemented rapidly.

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