Monetary policy, its effects
Monetary policy implementation is the main source of grumbling among people who do not seem concerned about the three national economic goals.
These goals are economic growth, full employment and price stability. Though they are equally desirable, achieving them at the same time has been found difficult by all who engage in macro-economic management.
Monetary policy has to do with how much money should circulate in the economy. Excess money, also known as excess liquidity, brings about unacceptable levels of liquidity.
Inadequate money which amounts to credit squeeze brings about the opposite on inflation, known as deflation.
Deflation is often accompanied by growing unemployment due to a decline in investment.
It is the goal of monetary policy to achieve a rate of price increase which is only a small percentage just enough to encourage investors who want remunerative prices for their output, but not the sort of increase which amounts to double digit inflation.
The tolerable level of unemployment is defined as being somewhere near the point where the number of unfilled job vacancies matches the number of the unemployed who are actively looking for jobs.
Monetary policy must be in consonant with policies which are designed to stimulate forces of private enterprise and competition.
There must be government regulations to guide enterprise, but not such as would stifle private initiative.
Control over conditions which influence the quantity of money is inevitable in a money economy such as ours. The difficult question is whether monetary control can be used flexibly enough to influence the desired behaviour of expenditure, output, employment and prices.
Monetary restraint by, among other policies, raising the rate of interest, reduces the availability of credit. The fewer loanable funds cost very high, thereby retarding investment expenditure and creation of jobs.
Most central banks use three major instruments for controlling the quantity of money in the economy:
1. The power to fix the level of minimum reserves that commercial banks must have. This minimum is usually deposited with the central bank itself.
2. Engagement in open market operations. That is selling or buying securities such as bonds. When a central bank sells its securities to commercial banks it takes out some of the money from circulation. When it buys securities owned by commercial banks it increases the quantity of money circulating in the system which is then available for lending to businesses and individuals.
3. Change in the terms under which banks may replenish any deficiency in their reserves. This generally involves raising or reducing central bank lending.
All these instruments have direct impact on the economic variables, prices, employment and gross domestic product (GDP) growth rates. A change in monetary policy may, therefore, take such positive form of action as open market sales, increases or decreases in required reserve ratios or in discount (interest) rates.
A restrictive monetary policy results in reduction of credit available both to business sector and public at large. This comes about because interest rates rise.
The effect of the rise in interest rates will depend on the importance of interest as an element in the total cost of production. If the interest is a major element in the acquisition of raw materials, its rise will deter a firm from applying for more credit.
If interest rates do not constitute a major element in cost of production, they will not deter a firm from expanding its production. Those engaged in small-scale farming do not usually make use of bank loans as banks regard them too risky clients. Therefore, the present interest rate hikes do not affect them directly.
Which of the instruments of monetary policy is adopted may depend on political will. A political party that is in power will generally avoid a policy that aggravates unemployment. In Malawi price level seems to be a greater concern than unemployment.
