Monetary Policy: An overview

Monetary policy is a set of tools used by a nation's Central Bank to control the overall money supply and promote economic growth. It is a powerful tool to regulate macroeconomic variables such as inflation and unemployment.

Types of Monetary Policy

Monetary policies are seen as either expansionary or contractionary depending on the level of growth or stagnation within the economy.

1. Contractionary

A contractionary policy increases interest rates and limits the outstanding money supply to decrease inflation. 

2. Expansionary

During times of slowdown or a recession, an expansionary policy grows economic activity. By lowering interest rates, saving becomes less attractive, and consumer spending and borrowing increase.

Objectives of Monetary Policy

1. Inflation

Monetary policies can target inflation levels. A low amount of inflation is thought to be beneficial to the economy. When inflation is high, a contractionary policy can help.

2. Unemployment

Monetary policies can influence the level of unemployment in the economy.For instance, a monetary policy that is expansionary tends to reduce unemployment because it encourages economic activity and the growth of the labor market.

3. Currency exchange rates

Using its fiscal authority, a central bank can regulate the exchange rates between domestic and foreign currencies. For example, the central bank may increase the money supply by issuing more currency. In such a case, the domestic currency becomes cheaper relative to its foreign counterparts.

Tools of Monetary Policy

1. Open Market Operations

When the Central Bank purchases or sells government bonds and other securities, it is said to be conducting open market operations. When the Central Bank wants to ease the monetary policy, it buys securities from the public, thereby injecting more money into the economy. On the other hand, when it wants to tighten its monetary policy, the bank sells securities to the market, which in turn reduces the money supply, as the funds are flowing from the hands of investors to the Central Bank. 

2. Repo rate

Banking institutions traditionally borrow money from the Central Bank and pay an interest rate on their loan, which is known as the discount rate. An increase in the discount rate makes banks less likely to borrow reserves from the Federal Reserve. As a result, a rise in the discount rate decreases the number of reserves in the banking system, thereby reducing the amount of money available for circulation. On the other hand, a lower discount rate encourages banks to borrow from the Federal Reserve, thus boosting the number of reserves and the money supply.

3. Reserve Requirements

The amount of money banks are required to retain in deposits is referred to as the Reserve Requirement Ratio. Lowering this reserve requirement releases more capital for the banks to offer loans and thereby increases money supply. Increasing the requirement, on the other hand, reduces bank lending and slows growth.

Bangladesh Bank announced its "cautiously accommodative"/contractionary policy  in the second half of the current fiscal year in order to limit inflationary and exchange rate pressures. The Central Bank raised the repo rate to 6% from 5.75% and the reserve repo rate to 4.25% from 4%. The lending rate cap for consumer loans has also been eased, allowing banks to raise consumer-level interest rates by up to 3 percentage points. The Central Bank is taking necessary measures to gradually move towards a market-based, unified exchange rate regime (within a 2 per cent variation) by the end of this fiscal year.