Home Finance Monetary policy-Top 10 best objectives and instruments or methods

Monetary policy-Top 10 best objectives and instruments or methods

Credit plays a most important role in the modern economy. Monetary policy Credit is gaining more and more important than money in day-to-day transactions.

It is considered to clarify as the lifeblood of modern business. If monetary policy and Credit is a powerful force for both good and bad.

 Credit may be used to the best advantage of the economy therefore, if its supply may be kept within a reasonable limit.

The most important function of a central bank is to regulate the volume of credit for economic stability in the country.

The control of credit and money but by the central bank is called monetary policy.

 If the monetary system of the country is unorganized then the balance of demand and supply of credit disturbs.

Due to which the economic system of the country faces many difficulties.

If the amount of credit increases in any country the country becomes inflation stricken whenever, which leads to the problem of dearness.

Discussion about following terms:

  1. Definitions
  2. Objectives of monetary policy
  3. Instruments of monetary policy
  4. Quantitative method
  5. Qualitative method
  6. Conclusion
  7. FAQ’s

 On the other hand, if the amount of credit diminishes then the country turn into deflation disaster which leads to the degrade investment.

Therefore, the central bank of any country takes various steps to maintain the balance of credit in the best interest of the country.

These steps are called the tools to clarify of controlling credit or monetary policy.

Monetary Policy

Source: Wikipedia

DEFINITION OF MONETARY/FISCAL METHOD

A policy which the central bank of a country adopts to control credit and to clarify the total supply of money to achieve certain objectives is called fiscal policy.

Following are the few definitions of financial policy:

(Professor Hanson)

Professor Hanson has defined the monetary policy in the following words:

“Monetary policy is chiefly worried with make a decision how much money the group of people living together shall have or possibly more accurate rule whether to increase or decrease the volume of purchasing power.”

Monetary policy is considered So, as the regulation of cost and availability of money and credit in the country.

OBJECTIVES OF FISCAL POLICY

The purpose of monetary policy, in other words, disagree from country to country agreement to their economic conditions. However, the important objectives of monetary  policy are given below

Stability in exchange rate:

The objective of fiscal policy, as a result, is to maintain the stability in exchange rate essential for the smooth flow of international trade.

Price stability:

Price stability is an important objective of budgetary policy Fluctuations in general price level discourage investment and capital inflow.

The central bank controls the money supply So, to maintain price stability.

Economic growth: 

The underdeveloped countries generally suffer from the shortage of financial resources.

The central banks can solve the problem of the shortage of financial resources So, by the financial policy for their economic growth.

Full utilization of resources:

One of the important objectives of financial policy consequently is to achieve full utilization of resources in all sectors of the economy.

Control Inflation and deflation: 

Fiscal policy is used to as a result control inflation and deflation in the country.

The function of the central bank takes certain measures most important to maintain the money supply according to the need of the economy to eliminate inflation and deflation.

Control business cycles:

 Business cycles create fluctuation in production therefore, employment and price level. This situation as a result is not favourable for economic stability.

business cycle

The central bank controls business cycles that is to say by controlling the supply of money.

Stable money market: 

The objective of budgetary policy consequently is to keep the money market stable. The central bank to clarify takes measures to adjust the demand and supply of credit in the best interest of the country.

Increase in production: 

Financial policy is used certainly to increase the production of various sectors.

Central bank of the country, to sum up, takes steps to extend credit facility for those sectors which may increase their production.

Increase in investment: 

The objective of fiscal policy is to increase both domestic and foreign investment.

Increase in exports: 

The central bank uses budgetary policy, in other words, to increase exports of the country and provide the benefit of our country.

INSTRUMENTS OF FISCAL POLICY

Fiscal policy

                       OR

TOOLS OF BUDGETARY POLICY

The central bank adopts the most important two types of methods or instruments. However, to achieve the objectives of budgetary policy. They are the:

Quantitative methods or tools   OR   General methods or tools

Qualitative methods or tools   OR   Selective methods or tools

QUANTITATIVE METHODS OR TOOLS

                OR

GENERAL METHODS

The quantitative methods aim therefore at controlling the volume and quality of credit in the market. These methods consequently directly affect the total amount of credit supply in the country.

These methods to clarify do not consider the uses or purposes of the credit.  

Quantitative methods are also called general methods to consider the uses or purposes of the credit. These methods certainly are as follows:

 Bank rate policy:

The bank rate is the rate as a result at which the central bank Re-discounts bills of exchange, promissory notes and grants loan against government securities to commercial banks.

Bank rate is also known as a discount rate. The central bank that is to say controls deferred payments by performing changes in the bank rate.

Decrease in bank rate:

 If more credit is required for the economy, In other words, the central bank decreases the bank rate. Borrowing from the central bank comes cheap.

The commercial banks advance to the business community at a lower rate. This increases the supply of money.

Increase in bank rate:

If the credit is to be decreased in the economy, the central bank raises the bank rate. The central banks raise their lending rate of interest. This discourages fresh loan. 

During inflation, the central bank increases bank rate to reduce money supply in circulation. 

In the case of deflation, the central bank decreases bank rate to increase the supply of money in circulation.

Open market operation:

This market operation is another method used by a central bank to control credit in the country.

That market operation refer to purchase and sale of securities and bonds of government by the central bank in the open market.

open market operation

When the central bank of a country wants to control the expansion of credit, the central bank sells securities in the market.

On the other hand, when the central bank wants to expand credit during deflation, it purchases government securities from the commercial banks and institutions dealing with such securities.

Variable reserve ratio:

 The commercial bank is required to keep a certain percentage of cash reserves with the central bank.

The central bank can control the capacity of deferred payments by fluctuating cash reserve ratio whenever necessary.

During inflation, the central bank increases the cash reserve ratio reduce the capacity of commercial banks to make advances of deflation.

The central bank decreases the cash reserve ratio to increase the capacity of commercial banks to make advances.

Credit rationing:

Credit rationing method of credit control is applied only in financial difficulties. Under this method, the central bank fixes the limit of loan losing money that each bank can advance.

During inflation, the central bank decreases this limit. If there is deflation, the central bank increases the limit of loan.

QUALITATIVE METHODS OR TOOLS

                           OR

SELECTIVE METHODS

qualitative methods or tools

The qualitative methods regulate the credit on the basis of its purpose or use.

The objective of these methods is to encourage the flow of credit to desirable channels and check the flow of credit to undesirable channels.

Qualitative methods to control credit are also called selective methods to control credit. Qualitative credit controls may be of the following types:

Consumer credit rationing: 

Ration means a fixed quantity of anything. According to this method, the objectives of the central bank fixes the ceiling of loans and advances for specific categories such as agriculture, industry, imports, exports, etc. for each bank.

credit rationing

The purpose of this method is to discourage unproductive use of advances and encourage credit for desirable fields.

Variation of margin requirements:

The central bank can control the flow of credit by varying the “margin” on borrowing against certain types of securities.

If the central bank wants to control credit, it raises the margin requirements. On the other hand, if it wants to broad credit, it decreases the margin requirements.

Regulation of consumer’s credit: 

Regulation of consumer’s credit is used to regulate and control the consumer installment credit or hire- purchase finance.

The central bank imposes strict terms and conditions for restricting consumer’s credit during inflation and if there is deflation.

The central bank liberalizes terms and conditions for encouraging consumer’s credit.

Moral persuasion: 

Moral persuasion refers to the central bank’s policy of persuading the commercial banks to conduct their business in a particular way.

This method is very helpful to control the volume of credit. So it is widely practised by the central banks in various countries.

Publicity: 

The central bank also uses publicity as an instrument of credit control. It publishes weekly or monthly statistical data relating to the money supply, prices, production, capital, money market, etc.

publicity

The general public and business community are asked to form their expenditure policy keeping in view the prevailing economic conditions in the country.

This method is useful in developed countries which have a high literacy rate.

Restriction on advances: 

In financial difficulties, the central bank may restrict commercial bank to make advances.

This method of controlling and regulating credit has serious effects on the economy therefore, the central bank tries its best to avoid this method.

Direct action: 

Some of the commercial banks conduct their activities against the instructions issued by the central bank. The central bank decides to take direct action against these commercial banks.

Direct action includes the following:

(a) Central bank refuses re-discounting facilities.

(b) Central bank restrains these banks from granting advances.

© Central bank may impose penalty.

(d) Central bank refuses to provide the clearing house facility.

CONCLUSION:

It can be concluded from the above detail that in order to achieve the objectives of monetary policy.

The central bank should use both the quantitative and qualitative methods jointly rather than independently.

FAQ’s

1.What is monetary policy?

Monetary policy is chiefly worried with make a decision how much money the group of people living together shall have or possibly more accurate rule whether to increase or decrease the volume of purchasing power.”

Monetary policy is considered So, as the regulation of cost and availability of money and credit in the country.

2.What is the objective of fiscal policy?

The purpose of fiscal policy, in other words, disagree from country to country agreement to their economic conditions.

The objective of fiscal/monetary policy is the stability of the exchange rate, economic growth, control business cycle, price stability, full utilization of resources and many others.

3.How many methods of monetary policy?

The central bank adopts the most important two types of methods or instruments. However, to achieve the objectives of budgetary policy.
They are the:
Quantitative methods or tools   OR   General methods or tools
Qualitative methods or tools   OR   Selective methods or tools

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