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Unit 13: Macro Economic Policies: Monetary Policy

and social justice. It not only controls the money market but also provides adequate resources Notes
for development.
In a narrow sense, monetary policy means monetary measures and decision of a country which
aim at controlling the volume of money, influencing the level of interest rates, public spending,
use of money and credit while, in a broader sense, it refer to the monetary system which deals
with all those monetary and non-monetary measures and decisions having monetary effects.
In this unit, you will be introduced to the various instruments of monetary policy, and its
transmission and effectiveness.

13.1 Objectives and Relevance of Monetary Policy

Broadly speaking, the objectives of monetary policy include short run stabilization goal and
long term economic growth and development goal. The following are the specific objectives of
monetary policy:
1. High level of output (or national income)

2. High rate of economic growth
3. High employment
4. Price stability (or optimal rate of inflation – inflation rate is nominal anchor for monetary
policy)
5. Low inequality in the distribution of income and wealth (equity objective)
6. External stability or healthy balance of payment position (stability of external value of
domestic currency).
Monetary policy operates through changes in the stock of money. Money stock changes will
influences the level of aggregate demand and so the level of output or income. Two characteristics
of monetary policy are noteworthy. One is that it is an aggregative policy. Any allocational or
sectoral problems are beyond its domain and these are the concerns of credit policy. Second is
that it operates on the demand side and not on the supply side of the goods market (credit policy
can affect even the supply side of goods market).

!
Caution The objectives stated above may come into conflict with each other. A high rate of
economic growth objective may involve sacrificing to some extent the objective of high
level of employment. The objective of low inflation rate may call for accepting relatively
higher rate of unemployment (the trade-off implied by the Phillips curve). High growth
rate objective may come into conflict with equity objective. This is so because higher
degree of inequalities in income and wealth distribution are conducive to higher rate of
saving and economic growth rate.
The trade-offs are economy-specific and change with the situation in which an economy finds
itself.

Relevance of Monetary Policy

Changes in the money supply and also the source of that change in the money supply are
extremely relevant. Policies that regulate changes in money supply are also extremely relevant
to Macro Economic performance, e.g., banking policy, exchange rate systems, public finance,
etc. These are all forms of monetary policy. Only because interest rates are an ineffective means
of regulating monetary changes does not mean that monetary policy is irrelevant.

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