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DETAILED INTRODUCTION:
Link b/w MS and Prices, incomes and expenditure is reasonably predictable and stable i.e.
V=constant so that money incomes and money expenditures are directly affected by change
in MS.
If the link is not reliable, monetary policy cannot be implemented with such predictability.
SHORT-TERM EFFECT:
In short-term, monetary policy cannot be miracles cure for economy i.e. only a medium
term policy.
The short-term effect is unpredictable because:
The connection between interest rates and investment is not so much stable.
It only affects after a considerable time lag.
ADVANTAGE:
The interest rates policy can be more fairly implemented.
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3. GROWTH IN THE VOLUME OF CREDIT:
I.CREDIT SQUEEZED.
Lower credit lowers the amount of borrowing; hence decrease the aggregate
expenditure, so also NI.
II.HIGHER LENDING:
Higher lending will increase the amounts of funds available to consumers, firms to be
spent, so there is an increase in the aggregate expenditure i.e. increase in GNP i.e. NI.
However it is not a serious option in today’s highly competitive market economy and in the
absence of exchange controls.
This target cannot be achieved unless inflation at home is controlled which ensures the
chances of Appreciation/Devaluation.
EFFECT OF DEVALUATION/APPRECIATION:
The overall affect will depend upon the Elasticity of demand for Exports at abroad and
Elasticity of demand for Imports at home.
Theoretically this is the most appropriate monetary policy target, but cannot be practical
because of out datedness of available information.
In order to control the growth in Money Supply, a special reserve requirement is set by the
SBP on Banks.
There is always a minimum reserve ratio, which reduces the size of credit multiplier
(D=C/r), hence control growth in MS.
DRAWBACKS:
3. SPECIAL DEPOSITS:
(Controls interest rates and MS Growth)
SBP might call Sp. Deposits from banks. Interest is paid on them. Sp. Deposits are tied up
and hence are illiquid.
WORKING:
Exchange rates affect the BoP, inflation and economic growth so Government might seek to
achieve a target exchange rate for domestic currency.
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5. DIRECT CONTROLS ON BANKS LENDING:
(Controls growth in Money supply)
I.QUALITATIVE CONTROLS:
ADVANTAGE:
A way of bridging the time lag before other policies can be implemented.
DISADVANTAGES:
c. Direct controls tend to divert financial flows into other, often less efficient,
channels i.e. leakages are inevitable.
EFFECTIVENESS:
Direct controls are therefore rarely effective in dealing with the source rather than the
symptom.
II.QUALITATIVE CONTROLS:
1Orders;
2Suggestions; or
3Requests;
To:
1Restraint lending;
2Lending to priority sectors of economy; or/and
3Say no to private sector lending at all.
III.PRUDENTIAL CONTROLS:
The authorities oversight the banks and other FIs to ensure that they have adequate
capital structure, adequacy, liquidity (asset portfolio) and Foreign exchange
exposure.