Read this article to learn about the four main objectives of monetary policy in different countries.
(1) Neutrality of Money:
Those who advocate neutral money maintain that the variations in the quantity of money can generate oscillations in the economic system.
If the banks follow a cheap money policy, bring down the rates of interest, create more money and dishoarding of idle assets, it will bring, in turn, a state of prosperity.
On the other hand, if the banks follow a dear money policy, raise the rate of interest, encourage hoarding and destruction of credit money tends to have a depressing effect on the economic activities being performed in the economy.
Neutrality of money, however, does not mean that the supply of money is fixed or should remain fixed. The objective of the monetary authority in relation to the neutrality of money is simply to counterbalance the changes in the velocity of circulation of money so that the hoarding and dishoarding activities or the cheap or dear money policies do not cause serious fluctuations in real economic variables.
Patinkin has explained the neutrality of money as a situation in which changes in the quantity of money occur in such a way as to cause a proportionate increase in the equilibrium prices of commodities and leave the equilibrium rate of interest unaffected. This position of Patinkin has already been elaborated and does not hold good any more. In other words, money is not neutral as shown by Gurley and Shaw, H.G. Johnson and Metzler.
Economists like Wicksteed, Hayek, Robertson feel that the main objective of the monetary policy is the neutrality of money. The policy of neutral money aims at doing away with the disturbing effects of the changes in the quantity of money on important economic variables like income, output, employment and prices. This policy implies that the quantity of money could be so controlled as to have no negative effect on the prices, output and employment.
According to this theory money is to remain neutral, i.e., to cause no fluctuations. The advocates of neutral money believe that the worst disturbances in the modern economy are those originating in monetary changes. In their view creation and destruction of money spoil the equilibrium between demand, supply, production, consumption, etc. But when a neutral money is followed under a monetary policy there will be no fluctuations but only comparatively smooth adjustments.
As such the main aim of the monetary policy is not to deviate from the neutrality of money. In other words, monetary authority must keep the quantity of money perfectly stable—which means it must be kept constant under all circumstances. This, however, may not be possible because the changes in the quantity of money are needed to cope with the fundamental changes that take place in the economic structure.
According to Prof. Cole, “Monetary stability is in itself good and worth pursuing provided we do not make the mistake either of pursuing it as the only good or of confusing it with a rigidity of supply which may, in fact, induce not stability or a satisfactory level of economic activity but depression.” But this aim of monetary policy has been criticized by modern economists on several grounds who feel that a neutral money policy is not advisable particularly under changing and dynamic conditions of modern economies.
(2) Exchange Stability:
The traditional objective of monetary policy has been the achievement of stable exchange rates. This objective was primary, while stability of prices and output was secondary owing to the paramount importance of international trade in the economies of leading countries like England, Denmark, Japan, etc. For this, maintenance and proper conduct of the gold standard was considered to be the primary function of the monetary authorities.
This way, minor changes in exchange rates were easily noticed. These led to a lot of speculation and consequent dislocation of economies. This imposed on them periods of inflation and deflation. This objective is now considered to be of only secondary importance except in case of countries like Japan and England, whose prosperity still depends upon foreign trade.
However, in under-developed countries the relationship between economic growth and exchange stability occupies special importance because an underdeveloped country has to import materials and equipment’s for development, besides, heavy borrowings. The exchange rate, therefore, has to be so adjusted that the balance of payments position does not worsen.
(3) Price Stability:
In the 1930s, during and after the great depression (1929-33), price stability and control of business cycles became important objectives of monetary policy. Fluctuations in prices in the upward direction and more so in the downward direction create difficult problems of production and distribution, besides great economic unrest and political upheavals.
Stability of the price level, thus, becomes the chief aim of monetary policy. But this objective of monetary policy proved to be short-lived on the grounds that it was difficult to determine a satisfactory price level at which the general price level should be stabilized. Price stabilization policy is beset with many practical difficulties; it may remove indirect business incentives which come through a rise in prices. Moreover, the prices of different sectors and groups in the economy vary considerably and exhibit different trends.
Again, stability of prices does not lead to stability of business conditions. Keeping in view the great stress laid by transactions and cash balance theorists upon the evil consequences of inflation and deflation, some tried to enquire into the relationship of the full employment objective with that of the objectives of price stability. It may be noted that these two objectives are quite closely related though they are by no means identical.
Economic welfare would perhaps be maximum if we could attain full employment and keep price level stability simultaneously—this might be described as the ideal objective of the monetary policy. However, if it is generally agreed that the two objectives cannot be attained simultaneously, the goal of price stability would be the one of the sacrificed. This objective was, therefore, replaced by the objectives of full employment and economic growth with stability.
(4) Objectives of Full Employment and Economic Growth:
The objective of price stabilization is good but it is not always desirable. We happen to live in an age of welfare states and full employment policies. There was a time, when exchange and price stabilities were considered important objectives of monetary policies, but in recent years both price and exchange stabilities have been relegated to the background and full employment—its attainment and maintenance—has assumed greater importance as the goal of monetary policy. It is argued that the achievement of full employment includes automatically price and exchange stabilities.
Prof. Crowther is of the opinion that the main object of monetary policy of a country is to bring about equilibrium between saving and investment in the country at the level of full employment. Keynes was one of these economists who directed his efforts to discover, not only how and how well or ill a nation’s economy in any period is, but also what policies and decisions are needed on the part of the government to enable the economy to work as well as possible.
He was interested not only in diagnosing the aliments of the economy but also in prescribing right remedies for them. The pre- Keynesian classical type of monetary policy tried to accomplish the results in depression simply by making more central bank funds available at low rates of interest. But the ineffectiveness and inadequacy of such a policy in a depression was demonstrated both by the Keynesian analysis and the actual experience of depression of the 1930s, when the desire for liquidity made it impossible to increase funds for investment.
Thus, monetary policy is designed and used not only to cope with the acute booms and slumps when they have already taken place but to counteract the less extreme fluctuations in their initial stages. An appropriate monetary policy can, therefore, lessen fluctuations in general economic activities and can also reduce or prevent the degeneration of the economy.
Advanced economies like UK and USA may work normally at full employment level; the problem in such economies is how to maintain full employment, of avoiding fluctuation in the level of employments and production. In other words, how to have economic growth with stability.
On the other hand, the main problem of an underdeveloped country is how to achieve full employment. Such an economy has to overcome under-employment of the entire agricultural population and has to remove unemployment of a large number of people who are without jobs for want of employment opportunities. Hence, a monetary policy designed to promote full employment through increased investment shall have to be followed.
Such a policy is the cheap money policy, which in turn, lowers the rate of interest so as to stimulate borrowing for investment, which through multiplier and acceleration effects goes to increase the level of employment. Once the level of full employment has been achieved, then through the equality of saving and investment, monetary policy tries to maintain it. For, if investment is greater than saving at full employment, inflation will set in, and if investment is less than saving, deflation will appear. It is, therefore, clear that the maintenance of full employment will also imply stable cost-price structure as also stable exchange rates.
For full employment is a very delicate situation and may be upset by changes in exchange rates or prices, which in turn, will lead to fluctuations in the balance of general economic activities. Thus, achieving and maintaining full employment is definitely superior in that all other objectives are automatically attained. Both in advanced as well as underdeveloped economies the objectives of exchange and price stability cannot be ignored. But they can be scarified to some extent in the short-run in favour of full employment and satisfactory growth. Moreover, they may, to some extent, be conflicting in short period over the long- run they are all complementary.