Monetary Policy

The policy made by the central bank or other regulatory boards of a country which ascertains the control of money supply in the economy is called monetary policy of a country,which in turn affects the interest rates. The actions undertaken are, alteration of interest rates,cash reserve ratio or statutory liquidity ratio.A monetary policy is basically the management of expectations.it takes the aforementioned measures to achieve the desired outcomes of an economy like stabilizing inflation and resource utilization around a sustainable level.

The goals of a monetary policy are to promote employment,fix moderate long term interest rates, stabilize prices and to achieve equilibrium in the balance of payments in order to achieve long term economic growth.The instruments used under monetary policy are of two types.they are;

1. General instruments– bank rate variations,open market operations and changing reserve ratios fall under this      category. This type of instruments are responsible for the regulation of overall credit level in the economy.

2. Selective instruments– consumer credit regulation falls under this category.This is responsible for controlling the    speculative activities within the economy.

The instruments used under the normal circumstances are policy rate and communication including the publication of forecast of inflation.During crisis instruments like lending at a fixed rate for longer maturity period  and adjustment of the size of assets are practised.

The type of monetary policy to be implemented is decided as per the convolution of the economic situation.It could be expansionary or contractionary.

Expansionary monetary policy– It is the monetary policy which facilitates an increase in the money supply and a  reduction in interest rates.The purpose of this is  to stimulate the economy to correct or prevent a contraction in  business cycle and to address the problem of unemployment.

Contractionary monetary policy– In contrast to the expansionary monetary policy, here, a decrease in the money supply and an increase in the interest rates are used to correct the inflationary problems of a business cycle  expansion.

Furthermore,monetary policy has been classified into

Accommodative- when interest rate set is intended to create economic growth.

Neutral- if interest rate set is intended neither to create growth nor to combat inflation.

Tight- if interest rate set is intended to reduce inflation.

Moreover, during crisis different unconventional monetary policies are used to overcome the situation. e.g.- in U.S. federal reserve used unconventional monetary policies for over four years to overcome the recession.

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