A Review On Monetary policy
The concept of money
Money can be defined as a means of exchange, a store of value, and a measure of value. Money can be defined as " any instrument or means by which goods and services can be exchanged and debt repaid”
Below we review the functions of money:
1 - medium of exchange:
Before the use of money, there was a so-called barter system, through which a good or service is exchanged for another good or service. Due to the difficulty of dealing with such a system, which requires the compatibility of desires between the parties involved in the exchange of goods and services, as well as the difficulty of fragmentation of the goods we trade, a specific commodity, such as gold and Silver, has been used as the means of exchange and access to various goods and services. Considering the difficulties associated with dealing with gold and silver, such as the heavy weight and the possibility of theft, individuals have tended to use cheap banknotes and metals, in order to use them as a medium for the exchange of various goods and services, due to the ease of carrying them and the low cost of manufacturing them.
2. Measure of value:
That a barter system requires knowledge of the relative prices of all goods and services existing in the economy. Suppose there are three commodities in the economy (A, B , C), we need to know four relative prices between these commodities. Having (5) goods requires knowing (10) at least relative prices. However, the existence of money solved the problem of the multiplicity of relative prices among all goods and services, where money was considered the unit of account, through which we can compare the prices of different goods and services.
3 - store of value:
Under the barter system, goods cannot be stored for future use (savings), due to the different nature and storage capacity of goods, or the difficulty of holding large quantities of gold and silver, for example (in the form of wealth). However, under the paper cash system, it is easy to hold cash in order to store purchasing power at the moment and then use it in the future.
In order for the individuals can use the cash in the exchange of goods and services, there must be two prerequisites: first binding legal money backed by the government, and secondly the confidence of individuals in accepting money to complete the process of exchange of goods and services.
The definition of monetary policy
A set of actions taken by the Monetary Authority represented in the central bank for achieving monetary stability in the community.
Monetary policy objectives
Stabilize the overall level of prices.
*Achieve a balance between the amount of money in circulation (money supply) and the level of economic activity.
*Contribute to the achievement of balance of payments support and external value of the national currency.
* Contribute to increasing the level of employment by increasing effective demand and increasing the level of investment.
* Overcoming the economic fluctuations (boom or bust) to which the state economy is exposed.
Types of monetary policy
Expansionary monetary policy:
It aims to remedy the recession or deflation experienced by the economy resulting from the imbalance between real output and cash flows in the society as the real output is greater, which leads to the intervention of the monetary authority by increasing the volume of money supply through the tools at its disposal, which leads to an increase in actual demand and thus
Deflationary monetary policy:
This policy aims to remedy the situation of inflation resulting from an increase in the volume of money supply than the increase in the volume of real output, and thus monetary policy seeks to limit the creation of money and reduce the money supply to a level commensurate with the real supply of goods and services.
Monetary policy tools:
There are quantitative tools this type of tools, all of:
1 - The Discount Rate is an interest rate charged by the central bank for providing loans to banks trade, with these banks to discount commercial papers at the central bank to provide liquidity is not. This instrument is one of the oldest used by the central bank to influence the level of liquidity and the volume of domestic credit.
The effect of the Discount policy in the event of inflation the central bank raises the rate of Discount of its commercial papers to limit the ability of banks to expand the granting of credit and thus the volume of money supply decreases and inflation decreases.
It is worth mentioning that the relationship between the Discount rate and interest rates is a direct one, but in the event of a recession the central bank tends to lower the Discount rate.
The effectiveness of the Discount policy depends on the following conditions:
Commercial banks change their interest rates as the discount rate changes and in the same direction.
There should be flexibility in the demand for loans towards the change in the interest rate.
2. open market: means that the central bank carries out the sale and purchase of securities in the cash market.
The open market policy affects the size of domestic credit by changing the size of the means of payment (liquidity) and the interest rate. When the central bank purchases securities, this will increase the liquidity of the banking sector and hence the credit capacity of the sector and the volume of money supply.
The effectiveness of the open market in influencing liquidity depends on the availability of cash instruments in the market, and the compatibility of management between commercial banks and the central bank.
3-legal reserve instrument: legal reserve means a percentage of the liquid deposits held by banks with the central bank.
Initially the goal of the legal reserve was: to prevent sudden withdrawals by depositors.
Then it became: a tool used by the central bank to influence the ability of banks to create credit in times of inflation exceeds the central bank to raise the reserve ratio legal.