Macroeconomic Policy
Macro economic policy refer to the
instruments by which a government
tries to regulate or modify the
economic affairs of the country in
keeping with certain objectives
In other words, it “attempts to asses
the behavior of the economy as a
whole and to seek ways in which its
aggregate performance might be
improved”
Its two main instruments are :
1. Monetary policy &
2. Fiscal policy.
Its four main objectives are :
1. Full employment,
2. Priced ability,
3. Economic growth &
4. Balance of payments equilibrium.
Conflicts / trade-off in policy
objectives
1. Full employment and economic growth,
2. Economic growth & price ability,
3. Full employment & prices ability,
4. Full employment & balance of payments,
5. Priced ability & balance of payments
What is Monetary Policy?
The term monetary policy refers to actions taken by central
banks to affect monetary magnitudes or other financial
conditions.
Monetary Policy operates on monetary magnitudes or
variables such as money supply, interest rates and
availability of credit.
Monetary Policy ultimately operates through its influence on
expenditure flows in the economy.
In other words affects liquidity and by affecting liquidity, and
thus credit, it affects total demand in the economy.
Credit Policy
Central Bank may directly affect the money supply to
control its growth.
Or it might act indirectly to affect cost and availability of
credit in the economy.
In modern times the bulk of money in developed economies
consists of bank deposits rather than currencies and coins.
So central banks today guide monetary developments with
instruments that control over deposit creation and influence
general financial conditions.
Credit policy is concerned with changes in the supply of
credit.
Central Bank administers both the Credit and Monetary
policy
Aims of Monetary policy
MP is a part of general economic policy of the
govt.
Thus MP contributes to the achievement of the
goals of economic policy.
Objective of MP may be:
Full employment
Stable exchange rate
Healthy BoP
Economic growth
Reasonable Price Stability
Greater equality in distribution of
income & wealth
Financial stability
Price Stability: The Dominant
Objective
There is convergence of views in developed and
developing economies, that price stability is the
dominant objective of monetary policy.
Price stability does not mean complete year-to-
year price stability which is difficult to attain.
Price stability refers to the long run average
stability of prices.
Price stability involves avoidance of both
inflationary and deflationary pressures.
Contd..
Price Stability contributes improvements in the
standard of living of people.
It promotes saving in the economy while
discouraging unproductive investment.
Stable prices enable exports to compete in
international markets and contribute to the
strengthening of BoP.
Price stability leads to interest rate stability, and
exchange rate stability (via export import
stability).
It contributes to the overall financial stability of
the economy.
Instruments
Operation of Monetary
1. Discount Rate
(Bank Rate) Policy
2.Reserve Ratios Operating
Target
3. Open Market
Operations
• Monetary Base
• Bank Credit Intermediate
• Interest Rates Target
•Monetary
Aggregates(M3)
Ultimate
•Long term Goals
interest rates
•Total Spending
• Price Stability
Etc.
Instruments of Monetary Policy
Variations in Reserve Ratios
Discount Rate (Bank Rate)
(also called rediscount rate)
Open Market Operations (OMOs)
Other Instruments
Variations in Reserve Ratios
Banks are required to maintain a certain
percentage of their deposits in the form of
reserves or balances with the RBI
It is called Cash Reserve Ratio or CRR
Since reserves are high-powered money or
base money, by varying CRR, RBI can
reduce or add to the bank’s required
reserves and thus affect bank’s ability to
lend.
Discount Rate (Bank Rate)
Discount rate is the rate of interest charged by the central bank
for providing funds or loans to the banking system.
Funds are provided either through lending directly or
rediscounting or buying commercial bills and treasury bills.
Raising Bank Rate raises cost of borrowing by commercial
banks, causing reduction in credit volume to the banks, and
decline in money supply.
Variation in Bank Rate has an effect on the domestic interest
rate, especially the short term rates.
Market regards the increase in Bank rate as the official signal
for beginning of a tight money situation.
Open Market Operations (OMOs)
OMOs involve buying (outright or
temporary) and selling of govt securities by
the central bank, from or to the public and
banks.
RBI when purchases securities, pays the
amount of money by crediting the reserve
deposit account of the seller’s bank, which
in turn credits the seller’s deposit account
in that bank.
Selective credit controls
Its used to influence specific types of
credits for particular purposes
They usually take the form of changing
margin requirements to control speculative
activities within the economy.
Expansionary monetary policy
Its used to overcome a recession or a
depression or a deflationary gap
Restrictive monetary policy
Monetary policy designed to curtail
aggregate demand is called Restrictive
monetary policy (or dear money policy)
Its used to overcome an inflationary gap.
Scope & Limitations
Scope of monetary policy is severely
limited in controlling inflation.
The limitations are as follows:
1. Increase in velocity of money
A. commercial bank port folio adjustments
B. role of non-bank financial intermediaries
C. methods to make better use of available
money supply
2. Discriminatory
- a restrictive monetary policy is
discriminatory in its effects on particular
sectors of the economy
3. Threat to credit market
4. Threaten solvency of NBFIs
5. Alter expectations of borrowers and
lenders
6. Time lags
Role of monetary policy in
developing economy
To control inflationary pressures
To achieve price stability
To bridge BOP deficit
Limitations of monetary policy in
less developed countries (LDCs)
Large non-monetized sector
Undeveloped money & capital markets
Large no. of NBFIs
High liquidity
Foreign banks
Small bank money
Money not deposited with banks
On account of these limitations of monetary
policies in an under developed country,
economists advocate the use of fiscal policy along
with it.
