Transcript
Unit 2: The Economy
Lecture 3: Economic Objectives and Indicators – Part B
Unit 2 The Economy. Lecture 3 Economic Objectives and Indicators – Part B
Now the most important tools of monetary policy include reserve requirements, open market
operations, and the bank, or discount rate, policy. So the central bank requires banks to hold a
specified proportion or percentage of their depositors funds as cash reserves. Now in order to
influence the money supply and by extension the amount of credit that banks can give to their
borrowers, the reserve requirement can be changed directly by the central bank. So by
increasing the reserve requirement, that is, by increasing the percentage of depositors funds
that banks need to hold, that reduces the amount of money in the economy and reduces the
amount of credit that banks can extend. Obviously, the opposite is true if reserve requirements
are decreased. Open market operations involves the buying and selling of government and
other securities by the central bank to influence the supply of money in the economy and by
extension interest rates and the volume of credit. Now this is achieved in the following way.
Expansionary monetary policy involves increasing the supply of money. This is done by the
central bank buying securities. This puts money into the economy, increases the supply of
money, decreases interest rates which is the cost of money and stimulates credit extension and
growth because credit is now cheaper. Obviously contractionary monetary policy will be the
reduction of the money supply in the economy and this is achieved through the sale of securities
and this results in an increase in interest rates and a reduction in credit extension.
Now the final monetary policy tool is the bank or discount rate policy. Now the discount rate is
the rate at which banks borrow from the central bank. in South Africa we call this the
repurchase, or repo, rate. So banks borrow from the central bank primarily to meet temporary
shortfalls of reserves so by varying the repo rate in South Africa, the Reserve Bank can affect
market interest rates. So by increasing the repo rate, what it means is the cost of borrowing
from the central bank goes up and banks will tend to build up reserves and this should have a
negative impact on credit extension and interest rates. The opposite is true if the central bank
reduces the repo rate. So an accommodative or expansionary monetary policy reduces the repo
rate in South Africa and a restrictive or contractionary monetary policy is when the repo rate is
increased, as mentioned previously the South African Reserve Bank is the central bank of
South Africa. So here in South Africa the South African Reserve Bank influences the overall
lending policies of banks and the demand for money and the amount of credit in the economy
indirectly through changes in banks liquidity and interest rates in the money market and the
primary goal of the Reserve Bank is to achieve and maintain price stability. Now even though
the tools of monetary policy involve influencing money supply and interest rates, the indicator
that governments target after consultation with the Reserve Bank is actually inflation. So South
Africa uses inflation targeting to manage economic activity when using monetary policy. For us
here in South Africa, we target a band of inflation and the band is 3% to 6%.
Now in addition to fiscal policy and monetary policy there are also direct controls that can be
used to influence economic activity. Some of those direct controls include prices in income
policy. Here, there is attempt to control inflationary pressures by restraining price and wage
increases. There's also import controls and here quotas and tariffs on the importation of
products into a country can be used to correct the balance of payment deficits.
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