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Chapter- 01

Introduction

Introduction 01

Rational of the study 01

Objective of the study 02

Scope of the study 02

Methodology of the study 02

Limitations of the study 02

Chapter- 02

Body of the term paper

Monetary Policy 03

Reason of publishing 03

Scope & Objective of Monetary Policy 04

Types of Monetary Policy 05

Monetary Policy in Bangladesh 06

Tools & Strategy of Monetary Policy 06

Major tools used by Bangladesh Bank 07

Policy Target 12

Limitations of Monetary Policy 13

Chapter-03

Findings of the study 14

Conclusion 14

Bibliography 14

Chapter- 01

Introduction

“Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by loIring interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values.

In this report I tried to show that how monetary policy is related to the economy of our country & how it works in our country.

Rationale of the study

The case study is assigned by our course teacher Nafisa Rounok as a part of our

“Monetary Policy” course. The topic of our case study is “Monetary Policy in Bangladesh”. By conducting this study I can enhance our knowledge and skill to apply various research methods in professional life on higher educational life. The report has given us a chance to raise our quality in developing research instrument and its applications. By doing so, I can boost our acceptability in job market and develop our real life knowledge.

Objective of the Case Study

Primary objective

The main objective of the study is to know about the monetary policy used in our country.

Secondary objective:

The case study has the following objectives:

� To know about monetary policy & its types.

� Tools of monetary policy used by Bangladesh Bank.

� To know about the strategy of monetary policy.

Scope

There are huge scopes to work in the area of this Case Study. Considering the dead line, and exposure of the paper has been wide-ranging. The study “Monetary Policy in Bangladesh” has covered overall scenario of macroeconomics situation of Bangladesh. I have a chance to work on the economic variable used in modern economic world. By doing the assignment, I are able to know that the importance of monetary policy of our growing economy. In the case study I discussed about the importance, types strategy of monetary policy & tools of monetary policy used by BB.

Methodology

I have used the concept of the course, information of the case study.

Sources of Data

Here the secondary sources of information are used. The secondary sources are:

� Books.

� Website.

Limitations

While conducting the report on “Monetary Policy in Bangladesh”, some limitations Ire yet present there:

� Because of time shortage many related area can’t be focused in depth.

� Website in different organization of Bangladesh contains poor information.

Chapter-2

Monetary Policy

The regulation of the money supply and interest rates by a central bank, such as the Central Bank of Bangladesh in order to control inflation and stabilize currency. Monetary policy is one the two ways the government can impact the economy. By impacting the effective cost of money, the Bangladesh Bank as a controller of monetary policy can affect the amount of money that is spent by consumers and businesses.

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment. . Monetary theory provides insight into how to craft optimal monetary policy.

Monetary policy is the process by which the government, central bank, or monetary authority of a country controls

a) the supply of money,

b) availability of money, and

c) Cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy.

d) Monetary theory provides insight into how to craft optimal monetary policy.

Reasons of publishing Monetary Policy Statement

The objectives for which The Central Bank of Bangladesh adopts the half yearly MPS H2 FY11 are given below:

� To support the government’s goal of faster inclusive economic growth and poverty reduction, besides maintaining monetary and price stability.

� To anchor inflation expectation of the markets is 7.5% in FY12 and the existing rate is

10.17%. At present condition authority are unable to decrease the price of consumer products so it is wise to make the price stable by setting the inflation rate at 7.5%.

� Achieving an inclusive economic growth by facilitating productive sectors while

keeping inflationary pressure under control. By fixing inflationary rate the authority trying to increase the outcomes using the maximum infrastructure of the productive sectors which will contribute in the national income.

� Discouraging credit flows to unproductive sectors whereas increasing credit flow to

productive sectors. As we all know by increasing dependence on domestic goods and decreasing dependence on imported goods one country can go up to our expectations.

� To keep domestic borrowing conditions easy in a recessionary global environment,

the central bank has refrained from Reverse Repo operations since the last quarter of FY11 and has announced to continue it in the second half of the current fiscal year.

� It is set to strengthen its oversight on liquidity, capital adequacy and risk management

in banks and financial institutions to protect the domestic financial sector from instabilities of the kind now afflicting markets in advanced economies.

Scope of monetary policy

Monetary decisions today take into account a wider range of factors, such as:

� Short term interest rates;

� Long term interest rates;

� Velocity of money through the economy;

� Exchange rates

� Credit quality

� Bonds and equities (corporate ownership and debt)

� Government versus private sector spending/savings

� International capital flows of money on large scales

� Financial derivatives such as options, swaps, futures contracts, etc.

Objectives of monetary policy

The objectives of a monetary policy in Bangladesh aim at growth, stability and social justice. After the Keynesian revolution in economics, many people accepted significance of monetary policy in attaining following objectives.

� Rapid Economic Growth

� Price Stability

� Exchange Rate Stability

� Balance of Payments (BOP) Equilibrium

� Full Employment

� Neutrality of Money

� 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. Let us now see objectives of monetary policy in detail:-

Rapid Economic Growth

It is 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 the investment.

Price Stability

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.

Exchange Rate Stability

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.

Balance of Payments (BOP) Equilibrium

The BB through its monetary policy tries to maintain equilibrium in the balance of payments. The BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP equilibrium can be achieved.

Full Employment

'Full Employment' stands for a situation in which everybody who wants jobs get jobs. However it does not mean that there is a 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 then credit supply can be encouraged. It could help in creating more jobs in different sector of the economy.

Neutrality of Money

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.

Equal Income Distribution

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 longer 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.

Types of Monetary Policy

Monetary policy in Bangladesh

As stated in the Bangladesh Bank Order 1972, the principal objectives of the country's monetary policy are

1. To regulate currency and reserves;

2. To manage the monetary and credit system;

3. To preserve the par value of domestic currency;

4. To promote and maintain a high level of production, employment and real income; a

5. To foster growth and development of the country's productive resources in the best national interest.

Although the long term focus of monetary policy in Bangladesh is on growth with stability, the short-term objectives are determined after a careful and realistic appraisal of the current economic situation of the country.

Tools of monetary policy

Major instruments of monetary control available with Bangladesh Bank are the bank rate, open market operations, rediscount policy, and statutory reserve requirement.

The methods of credit control can be classified as follows:

Quantitative/ General Methods Qualitative/ General Methods

01. Bank rate policy 01. Rationing of credit

02. Open market policy 02. Direct action

03. Variation of reserve ratio 03. Regulation of consumers’ credit

04. Moral persuasion

05. Publicity

Strategy of Monetary Policy

The MPS (Monetary Policy Statement) starts with expression of the monetary policy frameworks in terms of the goals, instrument, and the channels of transmission. Maintaining price stability while supporting the highest sustainable output growth is the stated objective of monetary policies pursued by the Bangladesh Bank.

.

Major Monetary Policy Instruments Use by Bangladesh Bank

Bank rate

Bank rate, also referred to as the discount rate, is the rate of interest which a central bank charges on the loans and advances that it extends to commercial banks and other financial intermediaries. Changes in the bank rate are often used by central banks to control the money supply.

The rate which central bank lends money to the commercial banks and discounts bill of exchange is called bank rate. If central bank increases the bank rate then the commercial banks will increase their marker of interest rates. As a result the borrowers borrow less form commercial banks and amount of credit reduces in the economy. In an opposite way amount of credit will be increased in the country.

Impacts of Bank Rate Changes

BB(Bank rate) ↑ Effects: Increase (cost of credit, unemployment, price level); Decrease (Production, export, investment).

↓ Effects: Increase (other interest rate, investment, and export); Decrease (leakage of domestic capital, price level, import).

— Effects:

An stable situation is found CB(Interest rate) ↑ ↓ —

Borrowers(Advance) ↓ ↑ —

Increase= ↑ ; Decrease= ↓ ; Stable= ‘—’

BB: Bangladesh Bank ; CB: Commercial Bank.

Open market operations

Open market operations are the means of implementing monetary policy by which a central bank controls the short term interest rate and the supply of base money in an economy, and thus indirectly the total money supply. This involves meeting the demand of base money at the target rate by buying and selling government securities, or other financial instruments. Monetary targets such as inflation, interest rates or exchange rates are used to guide this implementation.

BB mainly injects or withdraws reserves from the banking system through open market operations (OMO). This is pursued in two ways:

The first type is the outright purchase or sale of approved securities through weekly auctions in volumes consistent with the growth paths for RM and M2 targeted in the annual monetary program. BB injects reserves into the banking system by purchasing approved securities and withdraws reserves from the banking system by selling them. By adjusting the amount and the officially acceptable interest rate at auctions, BB influences the successful bidding rate, and the subsequent public announcement of this rate can convey its intention regarding short-term interest rates.

For instance, if BB intends to raise short-term interest rates, it increases the scale of its auction in absorbing operations and raises its internally acceptable bidding rate so as to push up the successful bidding rate of the auction and thus mop up excess liquidity from the banking system, which influences short-term interest rates. Any significant changes in the interest rate may persuade the stockholders to recalculate their return through dividend discount window and may react accordingly.

The second type of OMO is repo (repurchase agreement) and reverse repo auctions. In order to facilitate liquidity management on a day-to-day basis, BB goes for second type of open market operation, either through repurchase agreement (repo) to temporarily add reserves or through reverse repurchase agreements (reverse repo) to temporarily withdraw reserves. Repurchase agreements are essentially short-term loans collateralized by underlying approved securities. BB buys the underlying assets for a given price with an agreement by the selling institution to buy it back at a specified date and price. As the counterpart of repo auctions, BB accepts excess funds from the banks in ascending order of interest rates to the extent needed to maintain the intended level of liquidity. It can be mentioned that BB has introduced repo and reverse repo operations from July 2002 and April 2003 respectively.

Impacts of the OMO

Reverse repo and repo interest rates are BB’s day to day instruments influencing the growth path of reserve money, ultimately to influence inflation via growth path of broad money.

Recently, in the backdrop of the global economic slowdown the routine reverse repo operations are also being used sparingly, to keep credit conditions easy;

Statutory reserve requirement

Statutory Liquidity Ratio(SLR)

The SLR is commonly used to contain inflation and fuel growth, by increasing or decreasing it respectively. This counter acts by decreasing or increasing the money supply in the system respectively. In terms of section 33(1) of the Bank Company Act of 1991, the Statutory Liquidity Requirement (SLR) is the minimum (in percentage of total time and demand liabilities) that a scheduled bank has to maintain in liquid assets with BB. The rate was set at 18 percent since 2005. Specialized banks are exempted while banks guided by Islamic laws are required to keep reserve at the concessional rate of 10 percent.

The objectives of SLR are:

� To restrict the expansion of bank credit.

� To augment the investment of the banks in Government securities.

� To ensure solvency of banks.

Value and Formula

The quantum is specified as some percentage of the total demand and time liabilities ( i.e. the liabilities of the bank which are payable on demand anytime, and those liabilities which are accruing in one months time due to maturity) of a bank.

SLR Rate = Total Demand/Time Liabilities x 100%

Cash reserve requirement (CRR)

The cash reserve requirement (or required reserve ratio or only reserve requirement) is a bank regulation that sets the minimum reserves each bank must hold to customer deposits and notes. These reserves are designed to satisfy withdrawal demands, and would normally be in the form of fiat currency stored in a bank vault (vault cash), or with a central bank. The reserve ratio is sometimes used as a tool in monetary policy, influencing the country's economy, borrowing, and interest rates.

BB requests banks to keep five percent of their demand and times liabilities on account at the central bank. Cash in till is not eligible for the CRR.

Impacts of SLR & CRR

Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) for scheduled banks are the other monetary policy tools, used sparingly in situations of drastic imbalances from major shocks.

Changes of SLR, CRR and Bank Rate and Impact on Interest Rates (percent)

Yea

r (e

nd

June

)

SLR

CR

R

Ban

k R

ate

Rea

l dep

osit

rate

Rea

l Len

ding

/ A

dvan

cera

te

Wei

ghte

d av

g. le

ndin

g/

Adv

ance

rate

Wei

ghte

d av

g.

Dep

osit

rate

Inte

rest

ra

te

Spr

ead

12 m

onth

avg

. in

flatio

n(B

ase

: 1995

-96=

100)

G

DP

gro

wth

1997-1998

20 5 7.5 2.71 9.73 13.69 6.67 7.02 3.96 5.40

1998-1999

20 5 8 -1.59 5.36 14.02 7.07 6.95 8.66 5.20

1999-2000

20 5 8 0.22 7.10 14.16 7.28 6.88 7.06 4.90

2000-2001

20 4 7 4.42 11.07 13.86 7.21 6.65 2.79 5.90

2001-2002

20 4 7 5.09 11.81 13.75 7.03 6.72 1.94 5.27

2002-2003

20 4 6 3.95 10.37 13.16 6.74 6.42 2.79 4.42

2003-2004

20 4 6 1.91 8.40 12.78 6.29 6.49 4.38 5.26

2004-2005

16 4 5 -0.18 5.18 11.01 5.65 5.36 5.83 6.27

2005-2006

16 4.5

5 -0.87 4.44 10.93 5.62 5.31 6.49 5.96

2006-2007

18 5 5 -0.48 4.90 12.06 6.68 5.38 7.16 6.63

2007-2008

18 5 5 -0.35 5.58 12.78 6.85 5.93 7.20 6.43

2008-2009

18 5 5 -2.99 2.35 12.29 6.95 5.34 9.94 6.21

2009-2010

18 5 5 11.9 7.0 4.9 6.50 5.90

Source: Annual Reports, BB

4 Lending channel: If SLR↓⇒ Bank lending ↑⇒ Bank investment ↑ that will↑ Y (output).

Cash flow channel: If SLR↓⇒ Cash flow of bank ↑⇒ Interest rate ↓⇒ Bank investment ↑ that will ↑ Y (output).

The Policy Target(s)

In this backdrop it is necessary that the monetary policy framework be articulated for greater clarity and transparency benefiting both the policy makers and the stakeholders. A policy system, where the goals are transparent and their achievement verifiable, directly adds to the credibility of the central bank, a major objective of this document is to define such a framework. In contrast, however, the challenge in the developing world is how to augment the capacity output through both productivity growths as well as via the installation of additional capacity. Hence the appropriate monetary policy strategy in the Bangladesh context would be to achieve the goal of price stability with the highest sustainable output growth.

Inflation Target

It is the general wisdom that monetary policy tools are of immediate influence in controlling inflation. However, contemporary evidence amply illustrates that monetary policy cannot deal well with the inflationary impact of external shocks such as the recent international price of oil & related energy products. Many central banks as a consequence focus on the core inflation which is typically constructed by subtracting the most volatile components (e.g. food & energy prices, indirect taxes, etc.) from the consumer price index (CPI). As a policy goal, core inflation may be a more credible target then CPI inflation. While there is no standard measure of core inflation in Bangladesh context at this time, the construction methodology is made complex by two facts. First is that food items constitutes nearly 60% of the CPI index, and while the appropriate commodity group weights may require a re-think, to ignore food entirely in defining the core inflation may render the construction a bit like throwing the baby away with the bath water. Secondly, in Bangladesh context, the volatility of the international energy prices appear not to filter down to the CPI since the relevant domestic prices is subsidized by the state. Periodic adjustment in administered energy prices have always lagged the world market changes in both the time line as well as in magnitude often most dramatically. While it may be useful to focus on the non-food component of the index (which occupies only 41.6% of the full CPI) in order to gauge at the build-up of underlying inflationary forces in the economy, it would be unwise to treat this alone as a valid measure of core inflation.

Growth target

GDP growth projections of the Medium Term Macroeconomic Framework (MTMF) in the government's National Strategy for Accelerated Poverty Reduction (NSAPR), modified appropriately in the light of unfolding actual developments, are used as output growth targets for the purpose of monetary policies.

Limitation of Monetary Policy in Developing Country

In developing country, monetary policy suffers from the following limitations —

In under developing countries, and capital markets are narrow and unorganized. Similarly, in the situations, the instrument the reserve requirement does not function properly. By its nature, monetary policy is not effective in the short run. The role of monetary policy is not compulsive but permissive. This seriously limits the efficiency of monetary policy in backward countries. In under developed society where liquidity trap is in existence monetary policy cannot work efficiently. Administrative honesty and firmness are not very rigorous in less regular countries which reduce the efficiency of monetary policy a policy a lot.

Lastly, the lag between the decision about a particular policy and its implementation also hinders the monetary policy in its success. Here we found that monetary policy suffers from various limitations in the developing country. So, it should be supplemented by fiscal policy to make it effective. Despite this information, monetary policy sets the tone of economic development in recent years.

Chapter-03

Findings and conclusion

Findings of the study The intension of this study is to know how to work with digital information system. The major findings of the overall study are discussed below:

� Objectives of the monetary policy.

� Tools of monetary policy used by Bangladesh Bank.

� Reason behind publishing the monetary policy.

� Know about the bank, interest, repo, reverse repo, etc.

� The overall economic & monetary scenario of Bangladesh.

Conclusion

The Monetary Policy Statement (MPS) is intended to outline the objective and the modalities of formulation & conducting of monetary policy by the BB, its assessment of the recent and the expected monetary and price developments, and the stance of monetary policies that will be pursued over the near term. Objectives of the monetary policies of BB as outlined in the Bangladesh Bank Order, 1972 comprise attainting and maintaining price stability, high levels of production, employment and economic growth in such a directed regime with little or no role of financial prices in influencing the magnitudes or directions of credit the present MPS provides the monetary policy stands that BB intends to follow during first half of FY11-12. The prime objective of the policy stance is to ensure the use of the financial instruments towards promoting real sector growth at its targeted level along with ensureing reasonable price stability. The policy stance takes into account recent developments in real, external, fiscal & monetary sectors of the economy and the near term macroeconomic outlook for the remaining period of FY11.

Bibliography

Books

� Frederic S. Mishkin; ‘The economics of Money, Banking, and Financial Markets’; 7th Edition. (International Edition: Pearson Book Company, 2008).

Web Sites

1. www.bb.org.bd 2. www.mof.gov.bd 3. www.economywatch.com 4. www.en.wikipedia.org