MONETARY POLICY

Monetary policy is concerned with the measures taken to regulate the supply of money; the
cost and availability of credit in the economy. further, it also deals with the distribution of credit
between uses and users and also with both the lending and borrowing rates of interest of the
banks. In developed countries the monetary policy has been usefully used for overcoming
depression and inflation as an anti - cyclical policy. However, in developing countries it has to
play a significant role in promoting economic growth.
The major objectives of monetary policy are:

• Price stability
• Full employment
• Exchange rate stability
• Economic growth
The various tools of monetary policy changes in the supply of currency, variation in the bank
rate and other interest rates, open market operations, selective credit controls.
Since monetary policy is one instrument of economic policy, its objectives cannot be different
from those of overall economic policy. the central bank of a country has the responsibility of
controlling the volume and direction of credit in the country. Bank credit has become these
days an important constituent of money supply in the country. The volume and direction of
bank credit has, therefore, an important bearing on the level of economic activity. Excessive
credit will tend to create inflationary pressure on the economy while deficiency of credit supply
may tend to cause depression or deflation. Lack of the availability of cheap credit may also
hinder economic development of a country.
Economic growth implies the expansion in productive capacity or capital. Stock in the
economy so that increase in real national output or income are attained. As is well known,
economic growth can be speeded up by accelerating the rate of savings and investment in the
economy.
1. Increase in the aggregate rate of savings in the economy
2. Mobilisation of these savings so that they are made available for the purpose of
investment and production
3. Increase in rate of investment
4. Allocation of investment funds for the productive purposes and priority sectors of the
economy.
Expansionary monetary policy
An expansionary monetary policy is used to over come a recession or a deflationary gap. When
there is a fall in consumer demand for goods and services, and in business demand for
investment goods, a deflationary gap emerges. The central bank starts an expansionary
monetary policy that ease the credit market conditions and leads to an upward shift in aggregate
demand. For this purpose, the central bank purchases government securities in the open market,
lowers the reserve requirements of member banks, lowers the discount rate and encourages
consumer and business credit through selective credit measures. By such measures, it decreases
the cost and availability of credit in the money market, and improves the economy.
Contractionary monetary policy
A monetary policy designed to curtail aggregate demand is called contractionary monetary
policy. it is used to overcome an inflationary gap. The economy experiences inflationary
pressure due to rising consumer’ demand for goods and services and there is also boom in
business investment. The central bank starts a restrictive monetary policy in order to lower
aggregate consumption and investment by increasing the cost and availability of bank credit.