Ever heard of the term monetary policy? In recent times, the governor of the Central Bank of Nigeria, Godwin Emiefele, and other top executives of the apex bank have been in the news almost every quarter of the year, to brief the press and the public on the outcome of the CBN’s Monetary Policy Committee. One then wonders what the impact of monetary policy on the economy is.
Monetary policy is a set of tools that a nation’s monetary authority (Central bank) uses to promote economic growth by controlling the overall supply of money (value, supply, cost, and direction of money) that is available to the nation’s banks, its consumers, and its businesses. Monetary policy is formulated based on inputs from a variety of sources. For example, the monetary authority may look at macroeconomic numbers such as Gross Domestic Product (GDP), Inflation, industry and sector-specific growth rates, and associated figures. The primary objectives of monetary policies are the management of inflation or unemployment, and maintenance of currency exchange rates
Types of Monetary Policies
Monetary policies can be categorized as either expansionary or contractionary: When it is expansionary, it is also described as (Dovish). A Divish Monetary Policy occurs when it is used as a tool to stimulate the economy by the authority of an apex bank. The expansionary policy maintains short-term interest rates at a lower than usual rate or increases the total money supply in the economy more rapidly than normal.
For Instance, if a country like Nigeria faces high unemployment due to a slowdown or a recession. In this case, the monetary authority can opt for an expansionary policy to increase economic
growth and expand economic activity. As a part of expansionary policy, the monetary authority often lowers the interest rates to promote spending money and make saving it unattractive. As a result, the increased money supply in the market boosts investment and consumer spending. In addition, lower interest rates mean that businesses and individuals can get loans on favorable terms.
On the other hand, a contractionary monetary policy which is sometimes referred to as (Hawkish) by economics and experts, occurs when authorities of a nation’s central bank increase interest rates to slow the growth of the money circulation and bring down inflation. The implication of this is slow in economic growth and may even increase unemployment. However, this is often necessary to moderate the economy and keep prices of goods and services in check.
How is Monetary Policy Implemented?
For monetary policy to be effective, it does not just exist on paper. For effectiveness, monetary policy is implemented using tools such as interest rates, cash flow, and open Market operations.
Interest Rate Adjustment
Interest rate adjustment is one of the tools for the implementation of monetary policy. Using this tool, a country’s central bank can influence interest rates by changing the discount rate, (base rate) an interest rate charged to banks for short-term loans by a central bank. in an instance where the CBN increases the discount rate, the cost of borrowing for the bank increases as banks will also increase the interest rates, they charge their customers. Thus, the cost of borrowing in the economy will increase while the money supply will decrease.
Cash Reserve Ratio (CRR)
Cash Reserve Ratio as a tool for monetary policy implementation is the minimum amount of deposit Commercial banks have to hold as reserves with the Central bank. By rule, commercial banks can not lend the CRR money to corporates or fund investments into new businesses, hence, banks can’t earn any interest on the money. By changing the reserve ratio, the central bank can influence the money supply in the economy. The CBN, may want to increase the money supply in the economy, using this tool, it would lower the reserve ratio. As a result, commercial banks have higher funds to disburse as loans, thereby increasing the money supply in an economy. On the other hand, for controlling inflation, the CRR is generally increased, thereby decreasing the lending power of banks, which in turn reduces the money circulation in an economy.
Open Market Operations (OMO)
Open market operations is also another tool through which the CBN controls the money in circulation. In this instance, the central banks buy or sell securities to commercial banks. When the central bank buys securities, it adds cash to the banks’ reserves. That gives the banks more money to lend. When the central bank sells the securities, it places them on the banks’ balance sheets and reduces its cash holdings. in this instance, the bank has less to lend. A central bank buys securities when it wants an expansionary monetary policy and sells same when it executes tight/contractionary monetary policy. Generally, the central bank tools work by increasing or decreasing total liquidity, which is the amount of capital available to invest or lend. It is also money and credit that consumers