What are the major objectives of monetary policy?

1. Exchange Rate Stability
Monetary policy is aimed at curbing foreign exchange fluctuation. Fluctuation in Forex are easily noticed and given wider publicity than fluctuation in the domestic price level. A major reason is that it encourages speculation in Forex which adversely affect foreign trade. Small countries depending too much on foreign trade cannot afford fluctuating exchange rates, which introduces lack of confidence and encourage capital flight (capital and other investment leaving the economy). On the other hand speculators thrive on to making a „fast back? (quick gain) which distorts foreign exchange. Foreign exchange stability is particularly important for countries depending on foreign capital. A stable exchange stabilizes international relationships. It also smoothens international trade and international lending though at the expense of domestic price stability.

2. Price Stability
A gentle rising price level acts as a stimulus for productive enterprises. It increases profit margins, induces new investments and takes the economy nearer to full employment. It gradually reduces the debt burden but it?s difficult to prevent it turning into a „ galloping or run away inflation? (super inflation). On the other hand falling prices favour consumers compared producers and may lead to unemployment. This has a fiscal implication in the way that it will affect tax yield. A stable price level should steer off both inflation and deflation. A stable price level is required to maintain the equity of long term contracts and hold the balance between creditors and debtors and between employees and workers. It?s worthy to note that the price level is a composite of different prices and can only be inferred from the index number. The price changes are only a symptom of maladjustment between money supply and supply of goods. But it is difficult to tell which requires adjustment i.e. money supply or the supply of goods. Thus stabilizing the price level is not easy.

3. Mopping up excess Liquidity
The overall liquidity position includes not only cash and stock in trade but also potential credit from banks and other sources of money. Monetary policy should aim not so much at the regulation of the supply of money but at the control of the general liquidity position of business in the economy. Both bank and non banks financial institutions create financial claims and engage in multiple creation of credit and multiple increases in the respective demand liabilities. There is need to control this creation of credit especially by non financial institutions.

4. Ensure Neutrality of Money
Money is only a medium of exchange and its role is purely passive i.e. to facilitate exchange. In its absence barter trade should establish the ratio of exchange or value. The relative values as established under barter should not be distorted by money. Money should reflect this relative values and not distort them. Money supply should be so managed as to make sure the same ratio of exchange are involved as it would be under barter. In this case money supply should be inelastic in case of a full employment but in case of underemployment, money supply should be flexible or elastic. Money supply should be stabilized to ensure that prices are not distorting economic activities. Prices should therefore reflect the real ratio of exchange. Under normal circumstances if money was to become neutral then it must be isolated from the price level. Fluctuation in the relative prices will register only in changes in demand and supply of good and services and the resulting allocation of resources would then truly confirm to the communities wants. It is the non neutral monetary policy that distorts the price levels. Non-neutral monetary policy has been criticized on the ground that it assumes a static economy. But again neutrality of money has been utilized on their liability to correct economic fluctuation.

5. Ensure control of Business Cycles
One important objective of monetary policy is to moderate the periodical cynical in the economic activities. In most cases, monetary policy control is effective in controlling a boom but not a depression which call for a fiscal policy. Monetary control has to be wisely used so as not to hurt the production

6. Full Employment
Full employment, job for all those willing to work at the current rate of wages. It does not mean job for all, all the time for the entirely labor force. Every state strives to achieve full employment. Keynes emphasized the role of monetary policy in raising national income and employment and equilibrium in the job market is reached at the level of full employment where job seekers get jobs at the current rate of wages. Hence monetary policy should aim at achieving the equilibrium between saving and investment at a level of full employment. If interest rates are pushed beyond the full employment output and real income does not increase, then inflationary pressures will develop.

7. Balance of Payment Equilibrium
Balance of payment is one component that tends to affect any economic performance. The traditional objective of monetary policy has been to establish a balance in the foreign payment position and this is done through manipulating bank rates. In the short run, a country facing an adverse balance of payments may raise bank rates. This will raise all other short run interest rates in the money market. This will arrest an outflow of foreign exchange reserves. It will also induce an inflow of funds from abroad as investor will be induced to invest in high interest earning assets. It will introduce more money supply. The raise in the interest rate would also encourage saving reduce spending and cause prices to fall. This would encourage export and restrict imports hence restoring the balance of payment equilibrium.

8. Economic Growth and Stability
Monetary policy should also induce economic growth and price stability. This can be done through authorization of banks to issue short-term credit to certain areas of the economy. Example includes agriculture, informal commercial/service industry. Thus
short term credit sometimes make-up for the shortage of funds hence ensuring that the affected sector grow with stability. Commercial banks which are controlled by the Central Bank expand credit when economic activity is contracting. In this case the Central Bank has to set up policies that ensure commercial banks lends to the needy sectors of the economy. Again the monetary policy must ensure that money supply that comes through credit does not affect production through increase in prices. In this case monetary policy must tame money supply to ensure all sectors of the economy grow with stability.

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Wilfykil answered the question on March 8, 2019 at 12:57