Research Report on Money Market and Monetary Policy

Abstract

Money is a token that is widely accepted as a medium of exchange. The token can be tangible like a coin or a note, or intangible like credit in a bank deposit. If the token is convertible on demand into a commodity like an ounce of gold or a bushel of wheat, the token is known as commodity money. All fiat money is issued by the Central Bank of the countries. Its value derives from the fact that it is the only kind of money acceptable in payment of taxes and for settling private debts in court. Those who have no tax liability have reason to acquire fiat money because it is of value to those who do. Thus fiat money can be viewed as a tax credit that is widely accepted as a medium of exchange. Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the tabla supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. A policy is referred to as contradiction if it reduces the size of the money supply or raises the interest rate. An expansionary policy increases the size of the money supply, or decreases the interest rate. Further monetary policies are described as accommodation if the interest set by the central monetary authority is intended to spur economic growth, neutral if it is intended to neither spur growth or combat inflation, or tight if intended to reduce inflation. There are several monetary policy tools available to achieve these ends. Increasing interest rates by fiat, reducing the monetary base or increasing reserve requirements all have the effect of contracting the money supply, and, if reversed, expand the money supply. The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various credit instruments, foreign currencies or commodities. All of these purchases or sales result in more or less base currency entering or leaving market circulation. It must now take into account such diverse factors 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 and financial derivatives such as options, swaps, futures contracts, etc. The financial system of Bangladesh consists of Bangladesh Bank (BB) as the central bank, nationalized commercial banks (NCB), Government owned specialized banks, Domestic private banks, foreign banks and Non-bank financial institutions. The financial system also embraces insurance companies, stock exchanges and the co-operative banks. Capital market, an important ingredient of the financial system, plays a significant role in the economy of the country. BB, like all other central banks uses its power to alter the money supply growth for the purpose of overall monetary management of the country. Bangladesh attempts to alter money supply growth generally through the following traditional tools such as Bank rate, Reserve requirement and Open market operation.