Meaning of Monetary Policy: Monetary policy, generally, refers to those policy measures of the central bank which are adapted to control and regulate the supply of money, the cost and availability of credit in a country. Monetary policy consists of those monetary decisions and measures the aim of which is to influence the monetary system.
According to Paul Einzig, an ideal monetary policy may be defined “as the effort to reduce to a minimum the disadvantages and increase the advantages, resulting from the
existence and operation of a monetary system.”
Broadly speaking, by monetary policy is meant the policy pursued by the central bank of a country for administering and controlling country’s money supply including currency and demand deposits and managing the foreign exchange rates. The central bank of a country through its monetary policy manipulates the money supply, credit, government
expenditure, and rates of interest in such a manner so that the monetary system may be benefited to the maximum extent.
Objectives of Monetary Policy: Economists have conflicting and divergent views as regard the objectives of monetary policy. Economists have from time to time mentioned different objectives of the monetary policy. In fact the objectives of monetary policy change according to the changes in the business activities an level of economic
development. Broadly speaking, the following are the main objectives of monetary policy:
We shall now discuss in brief each one of the above objectives of the monetary policy.
1. Stability of Exchange Rates: Most of the economics of the world today are open economies. These economies have maintained trade relations with other countries. International trade transactions take place on the basis of a fixed rate of exchange. Any change in the equilibrium rate of exchange will have deep repercussions on the balance of payments of a country. It is, therefore, essential to maintain stability in the exchange rates.
In gold standard, the exchange rate stability was maintained through the automatic working of the system. Free movement of gold from one country to another helped in correcting the disequilibrium in the balance of payments, whenever and d wherever it arose. But, the country had to sacrifice the domestic price stability for the sake of stability in exchange rates. The gold standard was finally abandoned after World War I, and since then the objective of stability of exchange rates has lost its significance.
However, in paper currency standard, stability of exchange rates is maintained through the device of devaluation or overvaluation of the currency, as the case may be. Now, in
most of the countries the monetary policy is directed towards achieving economic stability.
2. Price Stability: Economists like Gustav Cassel and Keynes argue that domestic price stability should be the main objective of central bank’s monetary policy. Violent fluctuations in prices create the problem of inflation and deflation which cause enormous hardships to consumers, wage-earners and other factor owners. Both post-war inflation and great depression of 30s have convinced the economists that the objective of monetary policy should be the stabilization of the domestic price level even if this stabilization may mean destabilization of the exchange rates.
The objective of price stability has been criticized on several grounds. Modern economists believe that the objective of monetary policy should not be restricted only to the price stability but to the stabilization of the economic activity at full employment
level in the economy. Moreover, the term ‘price stability’ is very vague. Price level may mean wholesale prices, retail prices, labor prices, and so on. The stabilization of general
price level is compatible with rising or falling of individual prices. Above all, the objective of price stability ignores the realistic requirements of a dynamic society. Thus, on account of the aforesaid limitations the objective of price stability has lost its significance in present times. It is now resorted to along with the currently more important objective, i.e. full employment.
3. Neutrality of Money: Prof. Hayek and some other economists belonging to the a Austrian School have emphasized upon the neutrality of money as the objective of monetary policy. The neutral money policy is based upon the assumption that money should only play the role of medium of exchange and should not work as a measure of value. In other words, the money supply should be regulated in such a manner that it may not affect the output, price, employment, etc. It is only by keeping the supply of money as constant that it can play neutral role.
It is however, wrong to assume that by keeping the supply of money as constant the fluctuations in the price level can be avoided. Even the money supply remains unchanged, but if velocity of circulation increases or decreases, it will definitely disturb
the price level. Thus, it is clear that the monetary authority cannot make the money neutral just by keeping its supply unchanged.
4. Full Employment: Full employment refers to a situation in which all those who are able and willing to work at he prevailing rates of wages get employment opportunities. Full employment, however, does not mean complete or total employment. Even at full employment level 2% to 5% resources may remain unemployed. Various forms of unemployment like involuntary unemployment, seasonal unemployment, frictional
unemployment and structural unemployment may exist at full employment level. It may not be very difficult for most countries to achieve the level of full employment but the
real problem is how to maintain it in the long run. Periodical fluctuations in the business activities may cause unemployment in the economic system. The monetary policy, therefore, should be directed to ensure that current investment exceeds current saving and
this can be done by creation of credit money or by the creation of additional bank deposits or by higher velocity of circulation. When full employment is achieved, efforts should be made to maintain equality between saving and investment at the full employment level.
According to Crowther, “the obvious objective of the monetary policy of a country should be to attain equilibrium between saving and investment at the point of full employment.”
5. Economic Growth with Stability: While for most of the developed countries the objective of monetary policy is to maintain equality between saving and investment at the
full employment level, the monetary policy in the undeveloped countries is directed towards achieving high rate of economic growth. Monetary authority in an underdeveloped economy can use different tools to promote economic growth.
Economic growth refers to a process whereby an economy’s real national income increases over a long period of time. By increase in real national income we mean more availability of goods and services in a country during a given period of time. Thus, economic growth means the transformation of society of a country from a state of under development to a high level of economic achievement.
The main hindrance in economic growth is the lack of investment activities in the underdeveloped countries. Monetary policy can play a very crucial role in promoting the
investment activities. Monetary policy can also discourage investment in less-productive or less-useful activities. In other words, monetary policy may be a mixture of ‘cheap’ and ‘tight’ monetary management, so as to encourage and discourage investment according to the requirement, so as to encourage and discourage investment according to the requirements of business activities. Besides, the monetary policy should also aim at
maintaining stability in the economy. Monetary policy should be directed towards achieving high rate of growth over a long period of time.