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Objectives of Monetary Policy

Broadly speaking, the following are the main objectives of monetary policy:

1.    Stability of Exchange Rates:
2.    Price Stability:
3.    Neutrality of Money:
4.    Full Employment; and
5.    Economic Growth with Stability.

We shall now discuss in brief each one of the above objectives of the monetary policy.

Stability of Exchange Rates

Most of the economies of the world today are open economies. These economies have maintained trade relations with other countries. International trade transactions take place on the basis of a fixed rate of exchange. Any change in the equilibrium rate of exchange will have adverse effects on the balance of payments of a country. It is, therefore essential to maintain stability in the exchange rates.

Price Suability

Economists like Gustav Cassel and Keynes argue that domestic price stability should be the main objective of central bank’s monetary policy. Violent fluctuations in prices create the problem of inflation and deflation which cause enormous  hardships to consumers, wage-earners and other factor-owners. Both post-war inflation and great depression of 1930s convinced the economists that the objective of monetary policy should be the stabilization of the domestic price level, even if this stabilization may mean destabilization of the exchange rates.

The objective of price stability has bee criticized on several grounds. Modern economists believe that the objective of monetary policy should not be restricted only to the price stability but to the stabilization of the economic activity at full employment level in economy. Moreover, the term ‘price stability’ is very vague. price level may mean wholesale prices, retail prices, labour prices, and so on. The stabilization of general price level is compatible with rising or falling of individual prices. Above all, the objective of price stability ignores the realistic requirements of a dynamic society. Thus, on account of the aforesaid limitations the objective of price stability has lost its significance in present times. It is now resorted to along with the currently more important objective, i.e., full employment.

Neutrality of Money

Prof. Hayek and some other economists belonging to the Austrian School have emphasized upon the neutrality of money as the objective of monetary policy. The neutral money policy is based upon the assumption that money should only play the role of medium of exchange and should not work as a measure of value. In other wards, the money supply should be regulated in such a manner that it may not affect the output, price, employment, etc. It is only by keeping the supply of money as constant that it can play a nocturnal role.

It is, however, wrong to assume that by keeping the supply of money as constant the fluctuations in the price level can be avoided. Even if the money supply remains unchanged, but if velocity of circulation increases or decreases, it will definitely disturb the price level. Thus, it is clear that the monetary authority cannot make the money neutral just by keeping its supply unchanged.

Full Employment

Full employment refers to a situation in which all those who are able and willing to work at the prevailing rates of wages get employment opportunities. Full employment however, does not mean complete or total employment. Even at full employment level 2% to 5% resources may remain unemployed. Various forms of unemployment like voluntary unemployment, seasonal unemployment, frictional unemployment and structural countries to achieve the level of full employment, but the real problem is how to maintain it in the long-run. Periodical fluctuations in the business activities may cause unemployment in the economic system. The monetary policy, therefore, should be directed to ensure that current investment exceeds current saving and this can be done by creation of credit money or by the creation of additional bank deposits or by higher  velocity of circulation. When full employment is achieved, efforts should be made to maintain equality between saving and investment at the full employment level.

Economic Growth with Stability

While for most of the developed countries the objectives of monetary policy is to maintain equality between saving investment at the full employment level, the monetary policy in the underdeveloped countries is directed towards achieving thigh rate of economic growth. Monetary authority in an underdeveloped economy can use different tools to promote economic growth.

Economic growth refers to a process whereby an economy’s real national income increases over a long period of time. By increase in real national income we mean more availability of goods and services in a country during a given period of time. Thus, economic growth means the transformation of society of a country form a state of under-development to a high level of economic achievement.

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