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The impact of monetary policy on consumer price index (CPI): 1985-2010

par Sylvie NIBEZA
Kigali Independent University (ULK) - Master Degree 2014

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2.1.2 Objectives of Monetary Policy

Broadly speaking, the objective of monetary policy is to influence the performance of the economy as reflected in factors such as inflation, economic output and employment. It works by affecting demand across the economy in terms of people and firms willingness to spend on goods and services (Federal Reserve Bank of San Francisco, 2004). The objectives of a monetary policy are similar, planning aims at growth, stability and social justice.

After the Keynesian revolution in economics, many people accepted significance of monetary policy in attaining following objectives ( visited on 17 September 2014):

· Rapid economic growth

· Price stability

· Exchange rate stability

· Balance of Payment Equilibrium (BOP)

· Full employment

· Equal income Distribution

These are the general objectives which every Central bank of a nation tries to attain by employing certain tools (instruments) of a monetary policy.

In Rwanda the Central bank has always aimed to control the expansion of bank credit and money supply, with special attention to the season needs of a credit.

The objectives of monetary policy in detail

( visited on 17 September 2014):

1. Rapid economic growth

It's the most important objective of a monetary policy. The monetary policy can influence economic growth by controlling real interest rate and its resultant impact on investment.

If the Central bank opts for a cheap or easy credit policy by reducing interest rates, the investment level in the economy can be encouraged. This increased investment can speed up economic growth is possible if the monetary policy succeeds in maintaining income and price stability.

2. Price stability

All the economics suffer from inflation and deflation. It can be also called as price instability. Both inflation and deflation are harmful to the economy. Thus, the monetary policy having an objective of price stability tries to keep the value of money stable. It helps in reducing the income and wealth inequalities. When the economy suffers from recession the monetary policy should be an easy money policy but when there is inflationary situation there should be a dear money policy.

3. Exchange rate stability

Exchange rate is the price of a home currency expressed in terms of any foreign currency. If this exchange rate is very volatile leading to frequent ups and downs in the exchange rate, the international community might lose confidence in our economy. The monetary policy aims at maintaining the relative stability in the exchange rate. The Central bank by altering the foreign exchange is tries to maintain the exchange rate stability.

4. Balance of Payment Equilibrium (BOP)

Many developing countries like Rwanda suffer from the disequilibrium in the BOP. The Central bank through its monetary policy tries to maintain equilibrium in the balance of payments. The BOP has two aspects: the BOP Surplus and the BOP Deficit. The former reflects an excess money supply in the domestic economy, while the later stands for stringency of money. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP equilibrium can be achieved.

5. Full employment

The concept of full employment was much discussed after Keynes's publication of the «General Theory» in 1936. It refers to absence of involuntary unemployment. In simple words «full employment» stands for a situation in which everybody who wants jobs gets jobs. However it does not mean that there is zero unemployment. In that senses the full employment is never full. Monetary policy can be used for achieving full employment. If the monetary policy is expansionary the credit supply can be encouraged. It could help in creating more jobs in different sector of the economy.

6. Neutrality of money

Economists such as Wicksted, Robertson and others have always considered money as passive factor. According to them, money should play only a role of medium of exchange and not more than that. Therefore, the monetary policy should regulate the supply of money. The change in money supply creates monetary disequilibrium. Thus monetary policy has to regulate the supply of money and neutralize the effect of money expansion. However this objective of a monetary policy is always criticized on the ground that if money supply is kept constant then it would be difficult to attain price stability.

7. Equal income distribution

Many economists used equal income distribution to justify the role of fiscal policy in order to maintain economic equality. However in recent years, economists have given the opinion that the monetary policy can help and play a supplementary role in attainting economic equality. Monetary policy can make special provisions for the neglect supply such as agriculture, small- scale industries, village industries, etc. and provide them with cheaper credit for long term.

This can prove fruitful for these sectors to come up. Thus in recent period, monetary policy can help in reducing economic inequalities among different sections of society.

The goal of monetary policy is set out in the National Bank of Rwanda (BNR) Law which requires the BNR to conduct monetary policy in a way to deliver price stability and in low inflation environment. Law no 55/2007 of 30/11/2007 governing the Central bank of Rwanda assigns to the BNR responsibility of formulating and implementing monetary policy.

According to article 5 of the same law, the main missions of the National Bank of Rwanda shall be:

· To ensure and maintain price stability

· To enhance and maintain a stable and competitive financial system without any exclusion

· To support Government's general economic policies, without prejudice to the two missions referred to in Paragraphs 1° and 2° above.

These objectives allow the National Bank of Rwanda to focus on price stability while taking into account of the implications of monetary policy for the whole economic activity and, therefore, price stability is a crucial precondition for sustained economic growth. The National Bank of Rwanda agrees on the importance of low inflation and low inflation expectations. NBR mission's assists businesses in making sound investment decisions, underpin the creation of jobs, protect the savings of Rwandans and preserve the value of the national currency.

In pursuing the goal of medium-term to long term price stability, the National Bank of Rwanda agrees with the Government on the objective of keeping consumer price inflation low and stable. This formulation allows short-run variation in inflation while preserving a clearly identifiable performance benchmark over time.

To achieve the price stability objective, the BNR currently operates in a flexible monetary targeting framework with the monetary base as operating target, broad money aggregate as an intermediate target and inflation as the ultimate goal. The BNR monitors movements in monetary base on daily basis in line with the targets as set in the annual monetary program.

In that exercise, the BNR uses several policy instruments mainly open market operations, discount rate and reserve requirement.

The key repo rate (policy rate) set by the monetary policy committee is used to signal the stance of monetary policy.

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