Monetary Policy Assignment

Added on - 22 Feb 2021

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@cfm302DgloMONETARY POLICY.It is one of the public interventionist measures aimed at influencing the level and pattern ofeconomic activity so as to achieve certain desired goals.It covers all the actions by the Central Bank and Government which influences the quantity, costand availability of money and credit in the economy specifically monetary policy works on twoprinciple economic variables, Aggregate supply of money in the economy, And Level of interestrates.Whereas monetarism is a doctrine it holds that in the monetary policy is the determinant ofaggregate demand. Keynes holds that in the short run fiscal policy is important and that monetarypolicy matters only in as far as it affects fiscal variables. Presently in Kenya Central Bank Kenyacarries out the technical work of formulating and executing the monetary policy.Objectives of Monetary PolicyIt’s important to understand the distinction between objectives or goals, targets and instruments ofmonetary policy. Where goals of monetary policy refers to the objectives which may be pricestability, full employment or economic growth targets refers to variables such as supply of moneyor bank credit, interests rates which are sought to be changed through so as to attain the objectives.The following are some of the goals or objectives which monetary policy may be expected toattain; -Attainment of Full EmploymentFull employment can be said to be consistent with the some little unemployment as potentialworkers search for employment. It is also argued that a certain amount of structural unemploymentis acceptable since individuals without jobs may not have the skills needed by employers at leastin the short run. Monetary policy can raise the level of employment by encouraging credit to labourintensive sectors like rural agriculture. In addition a policy that lowers the rate of interestconstitutes expansionary monetary policy and it is likely to lead to increased investment and hencemore employment opportunities.
@cfm302DgloAchievement of Price StabilityThis is the problem of avoiding inflation. Inflation reduces the ability of money to effectivelyperform its function, especially as a store of value and as a standard of deffered payments.Moreover price stability can be maintained by regulating money supply through the tools ofCentral Bank Such as discount rate, minimum reserve requirements and Open Market Operations.Price stability however does not mean absolutely no change in price i.e. a certain rate of inflationis inevitable.A high degree of inflation has adverse effects on the account. First, inflation raises the cost ofliving of the people and hurts the poor most. It sends many people below the poverty line. It alsomakes the export costlier and therefore discourages them, on the other hand due to higher pricesat home people are induced to import goods to large extent.Thus inflation has adverse effects on the balance of payments. Thirdly when due to a higher rateof inflation value of money is rapidly falling, people do not have incentive to save. This lowersthe rate of saving on which investment and economic growth depend. Fourthly, a high rate ofinflation encourages businessmen to invest in the productive assets such as gold, jewellery, realestate etc.To Attain Economic GrowthThis can be defined as a process where the real GNP per capital increases over a period of time.Monetary policy can contribute to this end by providing investment funds through cheaper creditand by mobilizing savings which can be used for investment. The investment funds can beallocated to those sectors with the highest rates of return. This better allocation of resources bringsabout increased output. Monetary policy can promote economic growth through ensuring adequateavailability of credit and lower cost of credit. There are two types of credit requirements forbusinessmen i.e. Working capital for importing needed raw materials and machines from abroad.Secondly, they need credit for financing investment in projects for building fixed capital.Easy availability of credit at low interest rates stimulates investment and thereby quickenseconomic growth. To ensure higher economic growth the adequate expansion of money supply
@cfm302Dgloand greater availability of credit at a lower rate of interest is needed. But large expansion of moneysupply and bank credit lead to the increase in aggregate demand which tend to cause a higher rateof inflation. This raises the question of what is acceptable trade off between growths and inflation.It may noted that the context of the openness of the economy and floating exchange rate system asis the case of the Kenyan economy today, the objective of achieving higher rate of economicgrowth through monetary measures may also conflict with the objective of exchange rate stabilityi.e. the value of Kenya shillings in terms of Us dollars and other foreign currencies.Whereas prevention of depreciation of the Kenyan shilling requires tightening of monetary policythat is; rising of interest rates, reducing liquidity of the banking system to that banks restrict theircredit supply. The promotion of economic growth requires low lending rates of interest and greateravailability of credit for encouraging private investment.To Maintain Equilibrium in Balance of Payments, BOPUntil the early 90s, Kenya followed fixed exchange rate system and only occasionally devaluedthe shilling with the permission of the International monetary fund. The policies of floatingexchange rate and increasing openness and globalization of Kenyan economy has made theexchange rate of the shilling quite volatile. The changes in capital inflows and capital outflowsand changes in demand for and supply of foreign exchange, particularly the US dollars arisingfrom the imports and exports causes great fluctuations in the foreign exchange rate of the shilling.In order to prevent large depreciation and appreciation of foreign exchange, the Central Bank ofKenya has to take suitable monetary measures to ensure the foreign exchange stability. When thereis mismatch between demand for and supply of foreign exchange, external value of the shillingchanges.For instance presently, in (July 2008) the depreciation of the Kenya shilling has been caused bythe increase in demand for dollars for financing the country’s imports, the surging inflationarypressures and excess liquidity in the market. Through the rise in the cost of credit and reduction inthe availability of credit, borrowing from the banks can be discouraged and hence reduction indemand for dollars. Higher interest rates in Kenya would also discourage foreign institutionalinvestors and Kenyan corporate to invest abroad which will work to reduce demand for dollars
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