AS THE BANK OF ZAMBIA IS SCHEDULED TO MAKE ITS QUARTERLY MONETARY POLICY STATEMENT TODAY, HERE IS WHAT YOU NEED TO KOW.
By- Paul Chilambwe
WHAT IS MONETARY POLICY? Monetary policy refers to the measures taken by the Central Bank to alter cost of money and money supply in the economy. Cost of money in this context referring to interest rates and money supply referring to the quantity of money in an economy. An example of such measures is the setting of the Monetary Policy Rate (MPR).
WHAT HAPPENS WHEN THE MPR IS INCREASED?
Upward adjustment of the MPR increases the cost of money as interest rates go up. Consequently, increased cost of money results in reduced demand for borrowing by both companies and individuals.
It should be noted that such adjustments do not only affect future loans but existing loans too as interest rates on current loans will have to be increased by the same basis points by which the MRP will be adjusted upwards. Secondly, the increase in interest rates will reduce the demand for loans by commercial banks and the citizens thereby reducing the quantity of money in the economy.
The other consequence of increasing interest rate through upward adjustment of MRP is that the Central Bank and commercial banks will retain more money in form of interest thereby reducing the quantity of money in people’s pockets and the economy. Reduced liquidity has the potential to slow down economic activity and increasing employment.
On a positive note, reduced liquidity allows the Central Bank to keep demand-pull inflation by reducing demand for goods and services.
WHAT HAPPENS WHEN THE MPR IS DECREASED?
Decreasing the MRP reduces the cost of money; loan-holders pay less interest on their loans and more people have access to cheaper loans. As a consequence, decreasing the MPR results in more money in people’s pockets and more money in the economy hence resulting in increased economic activities and more employment.
However, the more money citizens have in their pockets and the more money in the economy, the higher the demand for goods and services thereby resulting in demand-pull inflation where too much money will be chasing too few goods.
WHAT HAPPENS WHEN THE MPR IS REMAINS UNCHANGED?
Having discussed the consequences of adjusting the MPR both upwards and downwards, it follows that non-adjustment of the MPR has little to no consequences on money supply and could be a signal that the Central Bank is comfortable with the status quo and would therefore not want to influence liquidity in the economy in any direction.