The justification of Monetary Policy

A continuation from the previous blog, ( well i made this simple enough for dear readers to understand).

Whenever there is an inflation in the country, the government usually tend to reduce the money supply and reduce the purchasing power, how? this question can be answered from the previous post in this blog. However more importantly, when the government want to overcome inflation, they usually will reduce the money circulation in the country and makes money or currency become limited and people spend less than usual. Cost of borrowing which is interest rate is higher, and bank will restrict their loan policy and cost of borrowing become expensive.

 In the condition of recession, where money in circulation is not much, the government will apply the expansionary monetary policy, and increase the money in the circulation within the economy system. they reduce the interest rate and borrowing and lending become cheaper and people will spend more and more until the economy became stable, and high employment achieved. However, this only can be applied in the short-run. Why? this is because in the long run, increase in money supply may lead to inflation problem. we do not want that ,do we? for beginners SMEs, they can take advantage of the expansionary policy since they need the capital to run their businesses or productions.

During inflation, it is advisable for us to save more.

expansionary monetary policy is used to reduce unemployment, however, it is impossible for a country to reach zero unemployment due to frictional unemployment (people who between jobs and fresh graduates) and structural unemployment ( mismatch between job requirements and and the job skills).

There are 5 goals of monetary POLICY :

1. High employment
2. Economic growth
3. Price stability
4. Interest rate stability
5. Stability of Financial Markets

monetary policy

As stated, monetary policy is the government policy on money supply and credit creation. there two major types of monetary policies, contractionary or tight monetary policy and expansionary or easy monetary policy. inspite of the two consists of quantitative and qualitative instruments.

Quantitaves measures are:

1. Open Market Operations (OMO) - selling (inflation) and buying (recession) short term securities.
2. Variations of Legal Reserve Requirements - increase (inflation) and decrease ( recession) reserve requirements.
3. Funding - selling (inflation) and buying (recession) long term bonds.
4. Discount rate or bank rate - inrease (inflation) and decrease (recession) discount rate.
5. Interest Rate Policy - increase (inflation) and decrease (recession) interest rate.

Qualitative measures are:

For Inflation ;
1. Selective credit control -includes hire - purchase regulations (banking system may fix minimum down payment and maximum repaying period) and capital issue control ( CB issue directives to banks to give loans only to productive purposes)
2. Moral suasion - CB persuade the commercial banks to restrict their lending policy.
3. Special directives - CB set up directives and instructions to banks to reduce the volume of loans given to clients.

For Recession ;
1. Allowing and supporting the banks and financial institutions to advance credit to households and firms for productive and non-productive purposes.

Let us apply this in the REAL WORLD.
Aug. 14 (Bloomberg) -- Malaysia, which has raised interest rates three times this year, has “appropriately” shifted its monetary policy to support growth and keep inflation in check, the International Monetary Fund said.

The policy of a “measured pace” of rate increases “will help prevent financial imbalances in an environment of low interest rates while still supporting aggregate demand and limiting the drag on growth from needed fiscal consolidation,” the IMF board said in a statement e-mailed today following a July 30 meeting on the country’s economy.

Stronger manufacturing buoyed growth across Asia in the first half of 2010, prompting Malaysia and India to lead regional policy makers in raising borrowing costs. Malaysian central bank Governor Zeti Akhtar Aziz has raised the benchmark interest rate to 2.75 percent this year from a record low as economic growth surged to the fastest pace in at least a decade in the first quarter.

The IMF, whose discussions were based on the annual staff report on Malaysia’s policies, also said directors “took note of the staff’s assessment that the ringgit appears to be weaker than its equilibrium level in real effective terms.”

The Washington-based IMF predicts “favorable” near-term prospects in the Southeast Asian country, with growth of 6.7 percent this year and 5.3 percent in 2011.

--Editors: Christopher Wellisz, Paul Tighe

when we looked upon this, Malaysia economy is, as we know, is in the inflation condition. for your information, when the interest rate is high, this will lead to the strengthen of the currency, which make the value of the currency is actually appreciate which subsequently leads to the higher cost of production domestically. Thus, importation increase.

Is this Malaysian current policy is good? drop your comment please :