Monetary Policy Instruments: Definition, Types, Purpose, and Examples

Monetary Policy Instruments – Every country has a central bank which has the duty to regulate the smooth circulation of money in its sovereign territory. Monetary policy is one type of central bank policy to carry out its duties. However, what exactly is meant by monetary policy? Also, what are the monetary policy instruments that Sinaumed’s must understand as a citizen? Check out the full explanation in the following article.

Monetary Policy Instruments

As is well known, monetary policy is an economic policy towards controlling money circulation and economic growth. The main measures as macroeconomic variables are the unemployment rate and inflation. However, 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 is measured by bank interest rates. Conditions in which commercial banks lend funds to Bank Indonesia as the central bank with the aim of making money circulate in an orderly manner.

Note the following:

  • If the central bank raises interest rates, it will reduce the amount of money in circulation to overcome inflation

So, when interest rates are raised, people will be more interested in saving at banks, Grammeds. This happens because the money saved will get greater interest. Due to the high public interest in saving, the money circulating in society will also decrease.

  • If banks lower interest rates, it will have the effect of increasing the amount of money in circulation to overcome deflation

So, when interest rates are lowered, people will be more interested in using money because if you save, you will only get interest or a small profit.

2. Open Market Operations

When the government controls the circulation of money through the sale or purchase of securities owned by the government, what is used as an instrument of monetary policy is open operation.

Noteworthy:

  • If the central bank sells SBI, it will have the effect of reducing the money supply to overcome inflation

When SBI is purchased by the public, the money will be received by the central bank, which can reduce the money supply.

  • If the central bank buys SBI again, it will increase the money supply to overcome defaluation.

When the central bank buys SBI, the central bank will exchange them for money, so that the money circulating in the community will also increase.

3. Statutory Reserve Ratio Policy

Next, the monetary policy instrument is the mandatory reserve ratio. The mandatory reserve ratio is a policy of the central bank to increase or decrease commercial bank cash reserves.

Things to watch out for, Squad:

  • If the central bank increases cash reserves, it will reduce the money supply and serve to overcome inflation.

So, as a result, commercial banks have to hold more money in reserves so that the money supply can be reduced, Sinaumed’s .

  • If the bank reduces cash reserves, it will increase the money supply to overcome deflation.

So, commercial banks have to spend more money on the public rather than holding that money as reserves, so the amount of money in circulation will increase in the community.

4. Determination of Reference Interest Rates

To achieve monetary policy objectives, Bank Indonesia has the authority to control money circulation through interest rates.

  • Tight Credit is a central bank policy that is useful for reducing the amount of money in circulation in order to overcome inflation, meaning that strict conditions for granting will reduce the number of people or entrepreneurs to obtain credit, due to difficulties in obtaining credit with increasingly difficult conditions.
  • Loose credit is a policy of the central bank to increase the amount of money in circulation to overcome deflation, meaning that looser terms of provision will be useful for increasing the number of people or entrepreneurs who can get credit because the conditions are also simplified.
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The interest rate set by Bank Indonesia will be used as a reference for commercial banks throughout Indonesia to carry out their activities. Thus, the money supply can be increased.

5. Moral Appeal

Finally, the monetary policy instrument is moral appeal. In this case, Bank Indonesia as the central bank urges all commercial banks to adopt a policy of reducing or increasing loan interest rates

Definition of Monetary Policy

Monetary policy is a decision taken by the government to support economic activity through various matters related to determining the amount of money circulating in society.

The main objective of monetary policy is to maintain the stability of the availability of money in a country. Monetary policy must be carried out because the state’s money supply will affect 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. This is based on Law no. 23 of 1999 concerning Bank Indonesia Monetary Policy.

Definition of Monetary Policy According to Experts

  1. Soeharsono Sagir: Monetary policy demonstrates the ability of Bank Indonesia as a central bank to achieve its sole objective, namely to achieve and maintain rupiah stability (inflation and rupiah exchange rate under control).
  2. Sadono Sukirno: Monetary policy is the central bank’s steps to influence the amount of money supply and interest rates in the economy with the aim of overseeing the forms of loans and investments made by commercial banks.
  3. Suryana: Monetary policy is a government policy to influence the course of the economy by influencing the supply of money in society or by influencing interest rates.
  4. Natsir: What is meant by monetary policy is any action or effort by the central bank to influence the development of monetary variables (money supply, exchange rates, interest rates, and credit interest rates) in order to achieve the desired goals.
  5. Perry Warjiyo: Monetary policy is the policy of the monetary authority or central bank in the form of monetary aggregates in order to achieve the development of economic activities carried out by taking into account the cycle of economic activity, the nature of a country’s economy, and other fundamental economic factors.
  6. Muana Nanga: The definition of monetary policy is a policy carried out by the monetary authority by controlling the amount of money in circulation and interest rates to influence the level of aggregate demand and reduce economic instability.

In other words, monetary policy is a process in which the government, central bank, or a country’s monetary authority controls the supply of money, the availability of money, and the cost of money or interest rates in order to achieve growth-oriented goals and economic stability.

Monetary Policy Objectives

Bank Indonesia has the goal of achieving and maintaining stability in the value of the rupiah. This goal is in accordance with what has been stated in Law no. 3 of 2004 article 7 concerning Bank Indonesia. What is meant by stability in the value of the rupiah includes stability in the prices of goods and services as reflected in inflation.

To achieve this goal, since 2005 Bank Indonesia has implemented a monetary policy framework with inflation as the main target of monetary policy ( Inflation Targeting Framework ) and adheres to a free floating exchange rate system .

The role of exchange rate stability is very important to achieve price and financial system stability. Therefore, Bank Indonesia also implements an exchange rate policy to reduce the volatility of excessive exchange rates, not to direct the exchange rate at a certain level.

1. Ensuring Economic Stability

The economic growth of a country must be controlled and sustainable. This can be realized by balancing the flow of goods and services with the circulation of money. Therefore, the objective of monetary policy is to maintain economic stability by means of regulations and stipulations related to the circulation of money in society.

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2. Controlling Inflation

In order to suppress inflation, Bank Indonesia must establish policies with the aim of reducing money circulating in the community and maintaining the availability of money in banks. Thus, one of the objectives of the existence of monetary policy is to control inflation.

3. Increasing Employment

The next objective of monetary policy from Bank Indonesia is to increase the availability of jobs. The stability of the circulation of money makes production activities increase. With an increase in production activities, human resources are needed in its management. So that this can be useful for absorbing labor with the existence of jobs.

4. Protecting the Stability of Goods Prices in the Market

The next objective of monetary policy is to protect market price stability. When market prices are stable, it will foster public confidence in current and future price levels. So that the level of purchasing power that exists 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 influence domestic economic activities, but also those outside the country. One of the goals of monetary policy is to maintain a balance in the international balance of payments. This can be realized through the stability of the number of exported and imported goods which are equal in size. Therefore, it is not surprising that the government often conducts devaluations in this regard.

6. Encouraging Economic Growth

All impacts on monetary policy are expected to be able to stimulate economic growth. Because, in order to achieve this goal requires various successes from each component. For example, such as the availability of jobs, inflation rate control, production activities and demand for goods, and others.

Types of Monetary Policy Types

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

1. Expansive Monetary Policy

Expansionary monetary policy is a type of monetary policy that manages and regulates the circulation of money in economic activities. In this case, the main objective is to increase the circulation of money in society so that the wheels of the economy can increase.

2. Contractive Monetary Policy

Next, contractionary monetary policy is a type of monetary policy which is a policy taken as a step to reduce the circulation of money in society when inflation occurs. This was realized by selling government bonds, increasing bank interest rates, and increasing reserve requirements for banks.

Example of Monetary Policy in Indonesia

In practice, a lot of regulations have been implemented as a result of monetary policy in Indonesia. The following 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. Providing direct credit to many sectors or projects that require funds urgently. This is able to increase the amount of money in circulation because the sector or project must finance all activities as soon as possible.

2. Provision of Overdraft Facilities

When Bank Indonesia assists commercial banks that are experiencing short-term liquidity difficulties, this is an example of monetary policy using an overdraft facility . The assistance provided is short-term loans with high interest rates. This is done in the hope of being able to control the circulation of money so that it remains stable.

3. Issuance of Government Bonds

Furthermore, an example of monetary policy is by 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 means of a process of borrowing and borrowing funds directly on the Interbank Money Market within a 7-day period. This is done as an effort to support operating activity instruments in the open market.

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