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Monetary Policy: Definition

Monetary policy aims to manage the money supply and achieve goals like stable prices and full employment. It is implemented through expansionary or contractionary policies that increase or decrease the money supply. The main tools are open market operations, required reserves, and interest rates. In developing countries, objectives include full employment and resource mobilization, while developed countries focus on demand management and price stability. Pakistan has used inflation targeting and expansionary policies at different times. Monetary policy works to influence economic activity and control inflation.

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200 views4 pages

Monetary Policy: Definition

Monetary policy aims to manage the money supply and achieve goals like stable prices and full employment. It is implemented through expansionary or contractionary policies that increase or decrease the money supply. The main tools are open market operations, required reserves, and interest rates. In developing countries, objectives include full employment and resource mobilization, while developed countries focus on demand management and price stability. Pakistan has used inflation targeting and expansionary policies at different times. Monetary policy works to influence economic activity and control inflation.

Uploaded by

hasan hashmy
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Monetary policy

Definition:
“Monetary policy is concerned with deciding how much money the economy should have or
perhaps more correctly deciding whether to increases or decrease the purchasing power of
money”

To manage Money supply in order to achieve specific goals such as constraining inflation or
deflation, maintaining exchange rate, achieving full employment or eco growth. Monetary Policy
is made Semiannually & reported quarterly.

According to Macconal:
“Changing the money supply to assist the economy to achieve a full employment”

Types of Monetary Policies:


There are two types of monetary policy discuss here
 Expansionary
 Contractionary

Expansionary /Easy monetary policy:


In expansionary policy you increase the flow of money supply by putting money in
market Money Supply ↑ Inflation ↑ Price ↑

Contractionary / Tight monetary policy:

In contractionary policy you decrease the flow of money supply by taking out money
from the market Money Supply ↓ Inflation ↓ Price ↓

Objectives of Monetary Policy:

 Inflation Targeting
 Price level Targeting
 Monetary Aggregates
Inflation Targeting
Under this policy approach the target is to keep inflation under a particular definition
such as (CPI) Consumer Price Index at a particular level
Pakistan Monetary policy objectives 2001 - 2007 2001 – 2004 June – Expansionary 2004
July – 2007 – Inflation Targeting

Price Level Targeting


Price level targeting is similar to inflation targeting except that CPI growth in one year is
offset in subsequent years such that over time the price level on aggregate does not not
move
Pakistan Monetary policy objectives 2001 - 2007 2001 – 2004 June – Expansionary 2004
July – 2007 – Inflation Targeting

Monetary Aggregate
Under this policy approach there might be more then 2objectives e.g. increasing
economic growth & decreasing inflation which means using a balance of expansionary &
contractionary policies
Pakistan Monetary policy objectives 2001 - 2007 2001 – 2004 June – Expansionary 2004
July – 2007 – Inflation Targeting

Objectives are classified in two aspects:

 Under developed countries


 Developed countries

UNDER DEVELOPED COUNTRIES:

 To achieve full employment


 To have high Efficiency
 To have large scale of resources mobilization
 To increase Exports
 To have high investment
 To provide price and exchange stability
 To have efficient allocation and utilization of resources
 To raise living standards

DEVELOPED COUNTRIES
 To have high aggregate demand without inflation
 Eradicate inflationary and deflationary gap
 High research/ further development
 Providing assistance to other countries
 Gaining monetary control over others

Tools of Monetary Policy:

Tools which are used to achieve monetary policy objectives


 Monetary Base
 Open Market Operation
 Reserve Requirements
 Discount Window Lending
 Interest Rate

Monetary Base:
Monetary policy can be implemented by changing the size of the monetary base. This directly
changes the total amount of money circulating in the economy. A central bank can use open
market operations to change the monetary base. The central bank would buy/sell bonds in
exchange for hard currency. When the central bank disburses/collects this hard currency
payment, it alters the amount of currency in the economy, thus altering the monetary base

Open Market Operation:


A central bank can use open market operations to change the monetary base. The central bank
would buy/sell bonds in exchange for hard currency. When the central bank disburses/collects
this hard currency payment, it alters the amount of currency in the economy, thus altering the
monetary base.

Reserve Requirements
The monetary authority exerts regulatory control over banks. Monetary policy can be
implemented by changing the proportion of total assets that banks must hold in reserve with the
central bank. By changing the proportion of total assets to be held as liquid cash, the Federal
Reserve changes the availability of loanable funds. This acts as a change in the money supply.

Discount Window Lending


Many central banks or finance ministries have the authority to lend funds to financial
institutions within their country. By calling in existing loans or extending new loans, the
monetary authority can directly change the size of the money supply.

Interest Rate:
In this method interest rate is forced on market supply which alters the money supply, but this
method is not practiced because open market operation is used instead.

Monetary policy management in Pakistan:


Monetary policy management and financial sector stability are two primary roles of State
Bank of Pakistan (SBP). ... Monetary policy in Pakistan, in line with SBP Act, has been
supportive of the dual objective of promoting economic growth and price stability.

State Bank of Pakistan control or administer the supply of money in the economy. Monetary
policy works on the expansion and Contraction of investments and is associated with
consumption and expenditure. ... An increase and decrease of interest rates change the pattern
of economic activity.

Inflation and monetary policy:


inflation cause an increase in the overall price level within an economy. Demand-
pull inflation occurs when aggregate demand for goods and services in an economy rises more
rapidly than an economy's productive capacity. ... Rising energy prices caused the cost of
producing and transporting goods to rise.
One popular method of controlling inflation is through a contractionary monetary policy. The
goal of a contractionary policy is to reduce the money supply within an economy by
decreasing bond prices and increasing interest rates. ... So, spending drops, prices drop
and inflation slows

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