Why Monetary Policy Is Needed ?

What is Monetary Policy?

The word "Monetary" means concerned with money, Monetary Policy is one of the tools of the Central bank of the country to handle liquidity to create economic growth. Here liquidity means how much money supply is there floating in the economy.

So What Is The Purpose?

So Why do we need Monetary Policy? The Primary purpose of having a monetary policy is to control inflation and then reduce unemployment in the country. Two techniques Central Bank utilizes to control inflation. The first technique is to change money supply in economy and other is to change Rate of interest in the country, so you must be guessing how merely by adjusting money supply and setting interest rate can have an effect on inflation. Just imagine a simple example and apply it on an individual level. 

                        Suppose there are only two products in a country. Both cost 10$ each, and both products must have to be sold, and a person has only 20$, so the same person shall buy both items costing 10$ each. Now you are acting as Central Bank, and you supply that person with more money, i.e., 30$. Now that person has to buy both items at the price of 15$ each, See inflation effect comes here when there is the augmentation of the money supply, and this effect is due to no productivity in creating more items.

                            There are to two types of Monetary policy which Central Bank employs which depends on the state of inflation and economic progress of the country.

• Expansionary Policy
• Contractionary Policy

1. Expansionary Policy:

Expansionary Policy consists of specific actions of the Central bank to increase Money supply these actions are:

• Lowering of Discount rate 
• Purchasing of Government securities. 
• Reduction in Reserve Ratio Requirement. 

When Central Bank Employs Expansionary Policy:

Central Bank considers employing expansionary policy when there is

•  a slow down in the economic progress
• low inflation 

The primary goal here is to ramp up economic activities. Therefore, Central bank deploys techniques by lowering discount rates to encourage individuals and investors to borrow more money from the bank because of low-interest rate. This results in more investing activities in the country which can boost up already slow-paced economy and also this will create more employment opportunities. The central bank also involves in purchasing assets from banks. This action fosters the bank's tendency to lend more to individual and businesses. All these activities come with the price and that is increased inflation which is due to increase in demand in the overall economy 

   2. Contractionary Policy:

Contractionary Policy involves  to decrease money supply by taking certain actions these are:

• Increasing of Discount rate 
• Selling of Government securities. 
• Increase in Reserve Ratio Requirement. 

When Central Bank Employs Expansionary Policy:

This is a reverse situation to already mentioned above here Central Bank considers employing Contractionary policy when there is 

• a slow down in the economy 
• High Inflation

Economic activities are booming here due to which there is high inflation in the economy so to sedate the economic activities Central bank deploys techniques like to increase discount rates which discourage individuals and investors to borrow money from  the bank due to Higher interest rate which slows down the investing activities of the country. also may increase unemployment. Also, Central bank involves in the selling of securities to decrease the money circulation from the economy. 

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