Monetary Policy | Definition & Objectives

Monetary policy consist of the measures designed to regulate and control the volume, cost and the direction of money and credit in an economy, in order to attain certain given macroeconomic policy objectives.

Monetary policy therefore culminates in the action of the monetary authorities (headed by the central bank) aimed at controlling the money supply and credit conditions, so as to achieve certain macroeconomic objectives.

In Nigeria, the central bank is empowered to undertake monetary policy formulation and execution.

OBJECTIVES OF MONETARY POLICY

These refer to the definite macroeconomic goals which a country seeks to achieve at a particular point in time. They include:

Relative stability in prices

Attainment of high rate of or full employment

Achievement of a high and sustainable economic growth

Equilibrium balance of payments

Stable exchange rate

Relative Stability in Prices:

This means the avoidance of fluctuation in the general price levels, thereby eliminating uncertain ties in the economy.

This objective aims at eliminating inflation and deflation and thereby restoring confidence in the domestic economy. Price stability places a country on a more favorable competitive ground internationally.

However, the concept of price stability (constant price) is more utopian than real. So the question is what pattern of stability is desirable? Opinions suggest slowly raising the prices and slow fall in the prices with their supporting arguments.  

Attainment of a high rate of or full Employment:

 This objective seek to achieve the highest possible rate of employment or the lowest possible rate of unemployment, since there can hardly be zero unemployment.

Achievement of a high and sustainable Economic Growth:

This simply implies attainment of the highest possible level of production, given that the available resources are maximally employed.

If achieved, this objective will have the further effect on increasing the people’s standard of living.

The rate of economic growth considered “high or desirable” differs from one economy to another, and is dependent upon some other factors like the social and organizational structures, etc of society at any given time.

Equilibrium Balance Payments:

This objective concentrates on the avoidance of persistent or fundamental disequilibrium in the balance of payments especially that arising from deficits. It seeks to achieve equality of income (receipts) and expenditure (payments).

Stable Exchange Rate:

The exchange rate should be fairly stable for a reasonable length of time. Undue and unnecessary fluctuations should be avoided. This if achieved will promote international trade. Contractionary monetary policy can be applied here.

Evaluation of the Operation of Monetary Policy

It has been generally acknowledged that monetary policy can play only a limited role in a developing country like Nigeria, for several reasons.

  1. The existence of a large non-monetized sector would clearly act as an impediment to the success of monetary policy.
  2. The narrow size of the money and capital markets will equally hinder the effectiveness of the policy.
  3. In Nigeria, currency comprises a major proportion of total money supply which implies the relative insignificance of bank money in the aggregate supply of money, whereas the effect of changes in the central bank monetary policies will mostly be on bank credit.
  4. The increase in non bank financial institutions also poses a serious challenge to the effective implementation of monetary policies so long as these non bank financial intermediaries are excluded from the perfect control of the central banks.
  5. Oftentimes, many banks enjoy a high level of liquidity (excess liquidity) and changes in monetary policies cannot significantly affect the credit policies of such banks.
  6. Where foreign owned commercial banks exist, they can easily neutralize the effect of a strict monetary policy as they can replenish their reserves by selling foreign assets and they can also draw on the International Capital Market.

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