The Monetary Policy “Game.” Why It is so Important for the Economy?

In general, monetary policy is designed by the central bank of a country to regulate the circulation of money. It is an economic strategy chosen by the government for the principle purposes of regulating interest rates and the money supply. Monetary policy plays a dominant role in deciding the expansion or contraction in the aggregate money demand and supply.

This is the basic mechanism to control the monetary environment of the country. There are a few basic objectives of any monetary policy: currency rate, stability, interest rate, and the balance of payments.

Goals of Monetary Policy

Inflation is the condition where the general price level increases as a result of an increase in circulation of money and the velocity with which it increases. The value of the monetary unit decreases consequently. Inflation negatively affects the value of saving accounts and investments. The cost of goods concurrently rises thus causing demand to decrease. This may cause a general aversion to new investment.

In such situations, central banks will implement a policy that regulates the circulation of currency in the country. This policy is designed in such away to decrease the flow of money to the public. Monetary policy ultimately works to regulate or stabilize the fluctuations of important indicators in an economy.

The stability of the monetary position of an economy significantly influences monetary policy decisions. Stabilizing the currency is essential for encouraging new investors to enter into the market. Stable interest rates are another important factor which is considered while designing a monetary policy. There are variations in the degrees of exchange rates that reflect the country’s gain or loss through imports and exports.

Instruments for the implementation of Monetary Policy

Central bank considers the above mentioned points while drafting the monetary policy. There are three basic tools that are applied in policy making. These are;
Open market Operations
Reserve Ratio Requirements
The ‘Discount Window’ lending

Open market operations refer to the buying or selling of government securities (form of raising or abating the funds of the government) depending upon the target of the policy. It means that if there is inflation the government will intend to sell its securities. It will be done to decrease the flow of money in consumer’s hands.

On the other hand if there is deflation government will purchase its sold securities from the public to increase the money circulation in the country. It is the extensively utilized instrument for the regulation of money supply in an economy.

Reserve ration or reserve requirements is the portion of demand deposit liabilities. This reserved provision of deposits of commercial banks and other monetary institutions are needed to be deposited in central bank. Central bank increase or decrease the reserve requirements as per the economic conditions. To halt the flow of money central bank will increase the reserve requirement and in order to increase the money circulation bank will decrease the reserve ratio.

Discount Window is an economic term used for discounted lending of central bank to commercial banks and other financial institutions. Under required conditions the central bank allows the commercial banks and other eligible financial institutions to borrow money in order to control the liquidity of cash in economy.

The debt is made on discounted rate which is usually set below the short term market rate.
Every economy has its own stated conditions keeping in view to which monetary policy is designed. It plays a vital role in deciding the monetary future of an economy.

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