Monetary Policy of Bangladesh free essay sample

Police Monetary policy is the term used by economists to describe ways of managing the supply of money in an economy. Monetary Policy is the management of money supply and interest rates by central bank to influence prices and employment for  achieving the objectives of general economic policy. Monetary policy works through expansion or contraction of investment and consumption expenditure. According to Paul Einzig â€Å"Monetary policy includes all monetary decisions and measures irrespective of  whether their aims are monetary and non-monetary, and all non-monetary decisions and measures that aim it affecting the monetary system. According to Harry G. Johnson â€Å"Monetary policy employing the central bank’s control of supply of money as an instrument for achieving the objectives of general economic policy. † According to G. K. Shaw â€Å"By monetary policy we mean any conscious action undertaken by the monetary authorities, to exchange the quantity, or cost (interest rate) of money. † From the above discussion monetary policy may be defined as the central bank’s  policy pertaining to the control of the availability, cost and use of money and credit with the help of monetary measures in order to achieve specific goals. The Importance of Monetary Rule There is a difference in between â€Å"pegged† and â€Å"fixed† rates, which lies in the adjustment system. A fixed exchange rate is the monetary rule that contains an equilibrating mechanism of the balance of payments. The gold standard was a good example of fixed rates. Countries defined their currencies in terms of weights of  gold and exchange rates represented the ratios of the weights. This system got into trouble very rarely, as during war, countries turned to finance deficit etc. Success of  gold depends on fiscal prudence. A country fixes the exchange rate between its currency and an important foreign currency. A currency board works automatically to preserve equilibrium in the  balance of payments. Some writers now speak of a â€Å"currency board† in order to describe a fixed exchange rate system because there is a common confusion  between pegged and fixed exchange rate. A fixed exchange rate is a monetary rule that gives the country the monetary policy of the partner country. On the other hand  pegged rate is an arrangement whereby the central bank intervenes in the exchange market to peg the exchange rate but still keeps an independent monetary policy. A flexible exchange rate is consistent with any monetary policy at all hyperinflation. Some countries don’t have the option of fixing the exchange rate  because some countries are too small but one of the countries is too large to fix, such as United States. This is because there is no currency to fix the US dollar. In this case the only choice is inflation targeting or monetary targeting, which depends on inflation rate. Stability of the inflation rate is an important policy and low inflation rate produce more stable inflation rate. It is very important that monetary aggregates contain important information about the economy. So from all of these discussion we see that how monetary rules affect the economy and its importance infixing the exchange rate. Objectives of Monetary Policy Monetary policy aims and methods have changed over time. Both in developed and developing economies, monetary policies seek to maintain price stability by sustained stable output growth in the face of internal and external shocks that are faced from time to time. In developed economies like USA with production factors at or close to full employment, monetary policies are formulated typically with the output gap (difference between the actual and the longer run potential output) in view; the policy stance is eased to  provide stimulus at times of slowdown when actual output lags the longer run  potential, and the stance is tightened to slow things down when the economy overheats with actual output running ahead of the sustainable longer run potential. Diagnosing and treating asset price bubbles symptomatic of overheating are major  issues of current debate in monetary policy. For developing economies like Bangladesh with significant underemployment/under exploitation of production factors, stimulating higher growth is imperative for  rapid reduction and eventual elimination of endemic poverty, and is therefore an overriding priority. The stimulus provided by monetary policies in accommodating the growth aspirations must not however over step towards macroeconomic imbalance destabilizing and jeopardizing future growth; and the pursuit of monetary  policies comprise the continual balancing act of supporting the highest sustainable output growth while adjusting smoothly to internal and external shocks that the economy encounter from time to time. The primary objective of the Monetary Policy of Bangladesh is to outline the formulation and implementation of monetary policy of the Bangladesh Bank (BB), and to convey its assessment of the recent and the expected monetary and inflation developments to the stakeholders and the public at large. The Bangladesh Bank Order of 1972 outlines the main objectives of monetary  policy in Bangladesh, which comprises— To achieve the price stability. To regulate currency and reserves.  ¦To promote and maintain a high level of production, employment and real income, and economic growth, since independence BB operated under a variety of pegged exchange rate systems amid capital controls. To manage the monetary and credit system. To maintain the par value of domestic currency.  ¦ To promote growth and development of the countrys productive resources in the best national interest. Although the long term focus of monetary policy in Bangladesh is on growth with stability, the short-term objectives are determined after a careful and realistic appraisal of the current economic situation of the country. Inflation Target It is the general wisdom that monetary policy tools are of immediate influence in controlling inflation. However contemporary evidence amply illustrates that monetary policy cannot deal well with the inflationary impact of external shocks such as the recent international price of oil and related energy products. Many central banks as a consequence focus on the core inflation, which is typically constructed by subtracting the most volatile components (e. g. , food and energy  prices, indirect taxes etc) from the consumer price index (CPI). The Bank of Canada argues that it is the core concept that better predicts the underlying price stability in the economy. Hence as a policy goal, core inflation may be amore credible target than CPI inflation. While there is no standard measure of core inflation in the Bangladesh context at this time, the construction methodology is made complex by two facts. First is that food items constitute nearly 60 percent of the CPI index, and while the appropriate commodity group weights may require a re-think, to ignore food entirely in defining the core inflation may render the construction a bit like ‘throwing the baby away with the bath water. Secondly, in Bangladesh context, the volatility of the international energy prices appears not to filter down to the CPI since the relevant domestic prices are subsidized by the state. Periodic adjustments in administered energy prices have always lagged the world market changes in both the time line as well as in magnitude often most dramatically. While it may be useful to focus on the non-food component of the index (which occupies only 41. 6 percent of the full CPI) in order to gauge at the build-up of  underlying inflationary forces in the economy, it would be unwise to treat this alone as a valid measure of core inflation. Bangladesh’s Monetary Policy In the first years after liberation, the primary target of monetary policy of  Bangladesh was to regulate not the quantity of money, but the direction of the flow of money and credit in support of the government financial programmed. In 1975, Bangladesh entered into a standby-arrangement with IMF and the countrys monetary policy got a changed shape, which fixed an explicit target of safe limit of  monetary expansion on annual basis. With this change, Bangladesh Bank started setting short-term objectives of monetary policy in close collaboration of the government and tried to achieve the target by using the direct instrument of control. The principal target of monetary control was broad money (M2) i. e. , the sum of the currency in circulation and total deposits of money in banks. The targeted growth of  M2 depended on a realistic forecast of the growth rate of real GDP, an acceptable rate of inflation and an attainable level of international reserves. Bangladesh Bank took measures to monitor credit and monetary expansion keeping in view the price situation and international reserves position. Efforts were made to achieve the targeted growth of domestic credit and thereby, the money supply, through imposing ceilings on credit to the government, public, and private sectors. The major policy instruments available to Bangladesh Bank were to set credit ceiling on the banks and provide liberal refinance facility at concessional rate for  priority lending. According to the national economic policy, the banks were to  provide the desired volume of credit at an administered and low rate of interest. The Bangladesh Bank (BB) has been announcing its monetary policy stance on a  biannual basis through the Monetary Policy Statement (MPS) since January 2006. Objectives of the monetary policies of the Bangladesh Bank as outlined in the Bangladesh Bank Order, 1972 comprise attaining and maintaining of price stability, high levels of production, employment and economic growth. The policy stances envisage repo, reverse repo, and BB bill rates as the routinely employed policy instruments for influencing financial and real sector prices towards the targeted path of inflation. The annual monetary programmers adopt the reserve money (RM) and broad money (M2) as intermediate targets; supported by a framework for regular tracking of other  asset and liability side sub-aggregates. The present MPS provides the monetary  policy stance that BB intends to follow during the second half: January to June (H2) of FY08. The prime objective of the policy stance for H2 FY08 is to ensure the use of the financial instruments towards promoting real sector growth at its targeted level along with reasonable price stability. The policy stance takes into account recent developments in real, external, fiscal, and monetary sectors of the economy and the near term macroeconomic outlook for the remaining period of FY08.