Basics of Monetary Policy

In developed economies monetary policy has to serve the function of stabilization and maintaining proper equilibrium in the economic system. But in case of underdeveloped countries, the monetary policy has to be more dynamic so as to meet the requirements of an expanding economy by creating good conditions for economic growth. Monetary policy can be strategic, intermediate and tactical.

Under strategic or primary goals the following tasks are very important.

– Increase of employment among the population;
– Normalization of the price level;
– Containment of inflationary processes;
– Acceleration of economic growth;
– Increase in production volumes;
– Alignment (balancing) of the balance of payments of the state.

By contrast intermediate goals are realized by changing the interest rates and the amount of money in circulation. In this way, it is possible to adjust the current demand for the goods and to reduce (increase) the supply of money. The bottom line is to influence the level of price policy, attract investment, increase employment and increase production. At the same time, it is possible to maintain or revive the conjuncture in the money (commodity) market;

Tactical goals are of short-term nature. Their task is to accelerate the achievement of more important – intermediate and strategic objectives:

– Monitoring the supply of money;
– Control of the interest rate level;
– Control of the exchange rate.

Types of Monetary Policy
Each country chooses its own kind of monetary policy. It can vary, depending on external conditions, the state of the economy, the development of production, employment and other factors. The following types are distinguished:

1. Soft monetary policy (its second name is “cheap money policy”) is aimed at stimulating various sectors of the economy by regulating interest rates and increasing the amount of money. At the same time, the Central Bank performs the following operations: – Makes transactions on the purchase of government securities. All operations are conducted in the open market, and the proceeds are transferred to the banks’ reserves and to the population’s accounts. Such actions allow increasing the amount of money supply and improving the financial capacity of banks. As a result, the interbank loan is in great demand;
– Minimizes the rate of bank reservations, which significantly expands the lending opportunities for various sectors of the economy;
– Reduces the interest rate. As a consequence, commercial banks gain access to more profitable loans terms. At the same time, the volume of loans extended to the population on more favorable terms and the attraction of additional funds in the form of deposits.

2. Rigid monetary policy (its second name is “expensive money policy”) is aimed at imposing various restrictions, restraining the growth of money in circulation with the main goal – restraining inflationary processes. With a strict monetary policy, the Central Bank performs the following actions:
– Increases the limit of bank reservations. In this way, a reduction in the growth of the money supply is achieved;
– Raises the interest rate. For this reason, commercial structures are forced to stop the flow of borrowing from the Central Bank and to limit the issuance of loans to the public. The result is a suppression of the growth of money supply;
– Sells government securities. At the same time, transactions are made on the open market due to current accounts of the population and reserves of commercial credit and financial organizations. The result is the same as in the previous case – a decrease in the volume of the money supply.