Monetary policy: A key tool of the economy
Nepal Rastra Bank has started preparations for the formulation of monetary policy for the fiscal year 2025-26. The newly-formed Monetary Policy Committee has an uphill task of focusing on global practices, the context of Nepal and the path that it should take in the coming days against the backdrop of permanent pegging of Nepali currency with Indian currency and the absence of good governance in the country.
What is a monetary policy?
Before delving further, let’s begin with a key question: what is monetary policy?
Monetary policy is related to monetary or currency matters such as cash reserve ratio, statutory liquidity ratio, open market operations, repurchase obligations. It affects the money supply in the economy.
Who drafts the monetary policy? The central bank of a country—the Nepal Rastra Bank in the case of our country.
When talking about this policy, another related policy also comes to mind and that’s fiscal policy. This policy is used to monitor and influence the economy of a nation.
Fiscal policy is the “sister strategy” of monetary policy through which the central bank influences the money supply of the nation. Formulated by the Ministry of Finance, it deals with fiscal matters such as government revenue (tax policies, non-tax matters like disinvestment, debt collection, service charges, etc) and expenditure matters—grants, salaries, pensions, money spent on creating capital assets like roads, bridges and the like).
The twin policies deal with inflation (the rate of increase in prices over a given period of time). The main objectives of monetary policy are as follows:
To check inflation or deflation (increase and fall in prices, respectively) or price stability in the country, to safeguard the country’s gold reserves, exchange rate stability, elimination of cyclical fluctuations, achievement of full employment and accelerating economic growth, etc.
Dealing with inflation: A tight monetary policy that reduces money supply in the system—that is one way of dealing with escalating prices.
Dealing with devaluation: This is done by increasing money supply in the system, by adopting an easy money policy and a cheap money policy.
When the economy is devastated by a war or hampered by a recession, a dispute or disruption in the economic horizon is very beneficial. In such situations, a country may adopt a dear/cheap money policy.
There is also a distinct difficulty and confusion when it comes to grasping monetary policy. Some people tend to think that dear money means that its value is high in terms of goods and services i.e prices are low while some others think cheap money means that the value of money is low and prices have increased.
Which money policy is better: It all depends on the economic situation facing a country. Interest rate is an important tool for the implementation of an economic policy. There are times when an economic policy demands that the interest rate in the money market be kept low and sometimes it demands that the interest rate be kept high for fulfilling certain economic objectives.
After this discussion, we are now in a position where we can classify these two policies based on their respective uses. We can say that we can identify the time and reason i.e when and why we use one of these two policies.
A tight money policy is preferred when the balance of payments is heavy against the country or is in danger of remaining unfavorable and when there is reckless or unwise investment from industries/industrialists and when credit creation by the banks exceeds all prudent limits.
Limitations: Monetary policy has to face many difficulties, especially in underdeveloped countries like Nepal. The existence of a large non-monetized sector—one-third of the economy in underdeveloped countries—can seriously limit the scope of use of monetary weapons, but two-thirds of the economy provides a fairly large opportunity for monetary action. Moreover, in such countries, currency occupies a relatively more important place than bank deposits.
