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Understanding Monetary Policy Tools

The document provides an analysis of monetary policy, defining it as a set of tools used by a nation's central bank to control money supply and promote economic growth. It outlines the objectives of monetary policy, including economic growth, balance of payments equilibrium, inflation control, unemployment reduction, currency exchange rate regulation, and price stability. Additionally, it details the tools of monetary policy such as open market operations, interest rates, reserve requirements, moral suasion, and exchange rate management.

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5 views2 pages

Understanding Monetary Policy Tools

The document provides an analysis of monetary policy, defining it as a set of tools used by a nation's central bank to control money supply and promote economic growth. It outlines the objectives of monetary policy, including economic growth, balance of payments equilibrium, inflation control, unemployment reduction, currency exchange rate regulation, and price stability. Additionally, it details the tools of monetary policy such as open market operations, interest rates, reserve requirements, moral suasion, and exchange rate management.

Uploaded by

akungaogero003
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© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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POLICY ANALYSIS

ASSIGNMENT ONE
NAME: OGERO AKUNGA
REG NO: HDB223-2216/2021
1. Definition of Monetary Policy
It is a set of tools used by a nations central bank to control the overall money
supply and promote economic growth and employ strategies.
Monetary policy is commonly classified as expansionary and contractionary.
Expansionary monetary policy refers to the policies that aims to increase the
money supply for example by lowering interest rates. This is mainly applicable
during times of slowdown or a recession.
Contractionary policy increases interest rates and limits the outstanding
money supply to slow down growth and decrease inflation, where the prices of
goods and services in an economy rise and reduce the purchasing power of
money.
2. The objectives of monetary policy
i) Economic growth- monetary policy promotes economic growth by
maintaining equilibrium between the total demand for money and total
production capacity and further creating favourable conditions for saving
and investment.
ii) Equilibrium in the balance of payment- monetary policy aim to maintain
balance of payment at equilibrium.
iii) Control inflation – A low level of inflation is considered to be healthy for the
economy. If inflation is high, a contractionary policy can address this issue.
iv) Unemployment- an expansionary monetary policy generally decreases
unemployment because the higher money supply stimulates business
activities . that lead to the expansion of the job market.
v) Currency exchange rates- using its fiscal authority, a central bank can
regulate the exchange rates between domestic and foreign currencies
vi) Price stability-monetary policy tools help control the level of inflation in the
economy by maintaining a certain level of money supply in the economy.b
Tools of monetary policy
[Link] market operations- the federal reserve bank buys bonds from investors or
sell additional bonds to investors to change the number of outstanding government
securities and money available to the economy as a whole.
[Link] rates- The central bank may change the interest rates or the required
collateral that it demands. Banks will loan more or less depending on this rate. If the
rate is low the banks will lend more thus more money in circulation in the economy
and vice versa.
[Link] requirement-authorities can manipulate the reserve requirement ,the
funds that a bank must retain as a proportion of the deposits made by their
customers to ensure that they can meet their liabilities. A decrease in the reserve
requirement reduces the money supply in the economy and vice versa.
[Link] suasion – The central bank issues licenses or operating permit to deposit
money Banks and also regulates the operations of the banking system. It can from
this advantage, persuade banks to follow certain paths such as credit restraint or
expansion .In case of credit expansion ,banks lend more this increasing the amount
of money in circulation in an economy.
[Link] rate- By selling and buying foreign exchange, the Central Bank ensures
that the exchange rate is at levels that do not affect domestic money supply in
undesired direction through the balance of payments and the real exchange rate.

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