The Objectives of Monetary Policy

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Monetary policy is an important tool for any country’s economic development and overall economic stability. The objectives of monetary policy may vary from country to country depending on the economic and social condition of the country and other needs. Even in the same country, monetary policy has different objectives at different times. The main objectives of monetary policy in developing countries can be as follows.

Employment Generation

Employment can be generated through various monetary policy channels by formulating expansionist monetary policy. The major channels of monetary policy that may help to create more and more jobs are briefly explained below.

Interest Rate Channel

When money supply increases, interest rate decreases, when interest rate decreases, investment is likely to increase, and when investment increases, aggregate demand increases, and employment may be created.

Credit Channel

As money supply increases, so does credit flow, and as more credit flows, consumption, and investment increase, so does total demand, and employment is created.

Property Value Channel

As money supply increases, interest rates decrease, when interest rates decrease, demand for financial and other assets increases, so does the value of assets, and as a result, overall wealth increases, consumption and investment increase, and aggregate demand increases employment.

Exchange Rate Channel

As the money supply increases, the exchange rate falls. When the exchange rate falls, the export will increase, and so does aggregate demand and job creation in the economy.

Maintain Price stability

Price stability means that the economy does not allow excessive rise and fall in prices. An increase in prices of 2 to 4 percent each year is considered by economists to be a necessary increase in price level for economic growth. Therefore, controlling the rise in price level above this rate as well as preventing any fall in price level for a long time is a function of monetary policy and is known as price stability.

If the economy is under pressure to control inflation, then tightening monetary policy is followed. Similarly, if the economy is in a state of declining demand, contraction, and economic stagnation, then expansionist monetary policy is adopted.

Achieving High Economic Growth

For any country to achieve high economic growth, it is necessary to make proper use of the resources and means available in the country in the productive sector. Monetary policy helps to bring together small, scattered, and unused small financial resources across the country by increasing financial access, participation, and literacy of people, and helps to mobilize them in a way to increase productivity and production. Similarly, the monetary policy directs the banks and financial institutions to mobilize resources for the socio-economic development of the country by prioritizing the areas that need to be given priority. Thus, the monetary policy helps to achieve the highest economic growth in the country by using expansionist tools.

Exchange Rate and External Sector Stability

Depending on the economic condition and needs of the country, the central bank can increase or decrease the exchange rate of the country.  The central bank is trying to keep the exchange rate stable through devaluation and revaluation of the currency. The exchange rate is also influenced by the trend of exports and imports, the level of prices in the domestic market, and so on. Therefore, to maintain stability in the exchange rate, it is considered necessary to maintain stability in the price level. Similarly, credit expansion should be controlled.

Monetary policy is also playing a key role in providing stability to the external sector by improving the balance of payments situation. For this, a shrinking monetary policy can be formulated. When the money supply decreases, interest rates rise and investment declines. Decreased investment reduces the total demand for domestic and exported goods and consequently the value/prices of domestic production. As the prices of domestic products fall in the country, these items become cheaper in the external market, which helps to increase exports.

Similarly, the depreciation of the exchange rate through an increase in interest rates and increases in the flow of investment increases the demand for foreign exchange in the country. An increase in demand for foreign currency means a weakening of the domestic currency and this can be understood as a decline in the exchange rate. As the domestic currency weakens, imports may decline, exports may increase, and the balance of payments may become favorable.

Reducing Economic Inequality

Inequitable distribution of resources and unequal access to sources of income can be linked to economic inequality. Monetary policy plays a role in reducing such inequality and promoting financial access, financial literacy, and participation. Through monetary policy to reduce economic inequality, the central bank may direct commercial banks to extend credit to priority sectors, special groups, and marginalized and poor communities.

Conclusion

Monetary policy, as one of the important macroeconomic policies, plays a significant role in the attainment of several macroeconomic goals like price stability, external sector stability, job creation, efficient utilization of resources, obtaining higher economic growth rate, financial sector development, and financial sector development, etc. Different goals of monetary policy can be obtained by ensuring the mobilization of resources from unproductive and unused areas to productive and efficient areas.

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