Monetary Policy Definition, Purpose, Types, & Instruments

BANKING & FINANCES, ACTIVELYSHARE.COM — Monetary policy is one of the most important central bank policies.

Each country has a central bank in charge of regulating the smooth circulation of money in its sovereign territory. Monetary policy is one type of central bank policy to carry out this task.

But what exactly is monetary policy? What are the monetary policy instruments that we must understand as citizens? Check out the full explanation from ActivelyShare.com below.

Understanding Monetary Policy

Monetary policy is a decision taken by the government in order to support economic activity through various matters relating to the determination of the amount of money circulating in the community.

The main objective of monetary policy is to maintain the stability of a country’s money supply. Because the state’s money supply affects various economic activities, such as inflation, bank interest rates, and so on.

Therefore, the person in charge and implementer of monetary policy in Indonesia is Bank Indonesia as the central bank in Indonesia. This is based on Law no. 23 of 1999 concerning Monetary Policy of Bank Indonesia.

In addition to monetary policy, there is fiscal policy which is also useful in maintaining Indonesia’s economic stability. The difference is, fiscal policy is a decision that focuses on state revenues and expenditures.

The implementation of fiscal policy can be seen through tax management and APBN. Meanwhile, monetary policy in Indonesia can be observed through discount policies, bank interest rates, and so on.

Monetary Policy Objectives

As explained in Law no. 3 of 2004 concerning Monetary Policy of Bank Indonesia, the main objective of monetary policy is to maintain stability in the value of the currency.

In order to achieve this, many aspects influence the decision making of Central Bank’s monetary policy. The various objectives of monetary policy are listed below.

1. Ensuring Economic Stability

The economic growth of a country must be controlled and sustainable. This can be realized through the balance of the flow of goods/services with the circulation of money.

Therefore, the objective of monetary policy is to maintain economic stability through regulation and stipulation regarding the circulation of money in society.

2. Controlling Inflation

In order to suppress inflation, Bank Indonesia has established policies aimed at reducing money circulating in the community and maintaining the availability of money in banks.

Thus, one of the objectives of monetary policy is to control inflation.

3. Increasing Employment

The next objective of Bank Indonesia’s monetary policy is to increase employment opportunities. The stability of the money supply makes production activities increase.

With the increase in production activities, human resources are needed in its management. So that this is able to absorb labor with the availability of job opportunities.

4. Protecting Stability of Goods Prices in the Market

The objective of monetary policy is to protect market price stability. When prices are stable, it fosters public confidence in current and future price levels.

So that the level of purchasing power between periods remains the same. This price stability can be regulated through the balance of money circulation, demand for goods, and production of goods.

5. Maintaining the Balance of the International Balance of Payments

Monetary policy does not only affect domestic economic activity, but also abroad. One of the objectives of monetary policy is to maintain the balance of the international balance of payments.

This can be realized through the stability of the amount of goods exported and imported equally large. Therefore, it is not surprising that the government often conducts devaluations in this regard.

6. Encouraging Economic Growth

All impacts of monetary policy are expected to stimulate economic growth. Because in order to achieve this goal, it takes a variety of success for each component. For example, there are jobs available, control of inflation rates, production activities and demand for goods, and others.

Types of Monetary Policy

In making decisions regarding the circulation of money, Bank Indonesia uses two types of monetary policy. The description of the explanation is as follows.

1. Expansive Monetary Policy

This type of monetary policy that manages and regulates the circulation of money in economic activity is called expansionary monetary policy. In this case, the main goal is to increase the circulation of money in the community so that the wheels of the economy increase.

The manifestation of this type of monetary policy is through increased purchases of government securities by Bank Indonesia, lower interest rates, and lower reserve requirements for banks.

The impact of this policy not only stimulates business activity or consumer purchasing power, but also reduces the unemployment rate.

2. Contractive Monetary Policy

Next, the type of monetary policy is contractionary monetary policy where the policy is taken as a step to reduce the circulation of money in society when inflation occurs.

This was realized through the sale of government bonds, increased bank interest rates, and increased reserve requirements for banks.

Monetary Policy Instruments

As is well known, monetary policy is an economic policy towards the control of money circulation and economic growth.

The main measures as macroeconomic variables are the unemployment rate and inflation. But not only that, there are other monetary policy instruments, including the following.

1. Discount Policy (Discount Rate)

Discount policy is a monetary policy instrument that measures through bank interest rates. The condition in which commercial banks lend funds to Bank Indonesia as the central bank makes the circulation of the amount of money orderly.

When the circulation of money needs to be increased, Bank Indonesia lowers loan interest rates. On the other hand, bank lending rates will be increased when the money supply has to be reduced.

2. Open Market Operations

When the government controls the circulation of money through the sale or purchase of government securities, open operations are the instruments of monetary policy.

When Central Bank wants to reduce the circulation of money, the government sells securities. On the other hand, when the circulation of money needs to be increased, the government buys securities.

3. Mandatory Reserve Ratio Policy

Furthermore, the monetary policy instrument is the mandatory reserve ratio. When Bank Indonesia wants to reduce the bank’s cash reserves, the money is circulated in the community through loans.

Meanwhile, if the bank’s cash reserves must be increased, the money circulating in the community is withdrawn by increasing the interest rate on savings.

4. Determination of Reference Interest Rates

In achieving the objectives of monetary policy, Bank Indonesia has the authority to control the circulation of money through interest rates.

The interest rate set by Central Bank will be a reference for commercial banks throughout the country in carrying out their activities.

Therefore, the monetary policy instrument is the determination of the reference interest rate.

5. Moral Appeal

The last instrument of monetary policy is a moral appeal. In this case, Central Bank urges all commercial banks to implement a policy of reducing or increasing loan interest rates

Examples of Monetary Policy in Indonesia

In practice, many regulations are implemented as a result of monetary policy in Indonesia. Below is an example of monetary policy in Indonesia.

1. Implementation of Direct Credit by Bank Indonesia

First, an example of monetary policy is Bank Indonesia providing direct credit. Direct lending to various sectors or projects that require urgent funding.

This can increase the amount of money in circulation because it must finance activities immediately.

2. Provision of Overdraft Facilities

When Bank Indonesia assists commercial banks experiencing short-term liquidity difficulties, this is an example of monetary policy in Indonesia through an overdraft facility.

The assistance provided is in the form of short-term loans with high interest rates. This is expected to be able to control the circulation of money so that it remains stable.

3. Issuance of Government Bonds

Next, an example of monetary policy is issuing government bonds. In this case, the government is trying to collect funds from the public so that the money circulating in the community decreases.

4. Rupiah Intervention Program

The rupiah intervention program is an example of monetary policy in Indonesia carried out by Bank Indonesia by direct lending and borrowing processes in the Interbank Money Market within a period of 7 days. This is done as an effort to support the instrument of open market operations.

This is the discussion from ActivelShare.com regarding the definition of monetary policy, its objectives, types, instruments, and examples of monetary policy in Indonesia! Monetary policy is one type of regulation that is taken to maintain the country’s economic stability, so let’s support it!


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