AN ASSIGNMENT ON

MONETARY POLICY OF BANGLADESH

MBA 510 - Macro Economics
Submitted to
Adjunct Faculty

Submitted by
ID:
Section-1
MBA Program
Date: 13 August, 2014

INTRODUCTION:
Monetary policy, both in developed and developing economies, seeks to maintain price
stability accompanied by sustained output growth in the face of internal and external shocks
faced from time to time. For developing economies like Bangladesh with significant
underemployment/under exploitation of production factors, supporting higher output growth
is an overriding priority. Monetary policy of Bangladesh Bank therefore aims at maintaining
price stability while permitting monetary expansion needed to support output growth at
sustained high rate.
The Bangladesh Bank, thus, is not only responsible for monetary policy; it is also responsible
for development and regulation of the banking sector and key segments of financial markets,
foreign exchange management and public debt management. Though it is difficult but proper
coordination of these functions under one roof has been very helpful in preserving financial
stability along with low inflation and sustained high economic growth, and, therefore, to the
practice of independent monetary policy in Bangladesh.

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.

the supply of money

availability of money

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

Monetary theory provides insight into how to craft optimal monetary policy.
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OBJECTIVES OF MONETARY POLICY

The objectives of 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. These are given below in details

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

In practice, to implement any type of monetary policy the main tool used is modifying the
amount of base money in circulation. The monetary authority does this by buying or selling
financial assets These open market operations change either the amount of money or its
liquidity (if less liquid forms of money are bought or sold). The multiplier effect of fractional
reserve banking amplifies the effects of these actions.
Constant market transactions by the monetary authority modify the supply of currency and
this impacts other market variables such as short term interest rates and the exchange rate.
The distinction between the various types of monetary policy lies primarily with the set of
instruments and target variables that are used by the monetary authority to achieve their
goals.
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Monetary Policy:

Target Market Variable:

Long Term Objective:

Inflation Targeting

Interest rate on overnight debt A given rate of change in the CPI

Price Level Targeting Interest rate on overnight debt A specific CPI number
Monetary Aggregates

The growth in money supply

A given rate of change in the CPI

Fixed Exchange Rate

The spot price of the currency The spot price of the currency

Gold Standard

The spot price of gold

Mixed Policy

Usually interest rates

Low inflation as measured by the

gold price
Usually unemployment + CPI
change

The different types of policy are also called monetary regimes, in parallel to exchange rate
regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results in
a relatively fixed regime towards the currency of other countries on the gold standard and a
floating regime towards those that are not. Targeting inflation, the price level or other
monetary aggregates implies floating exchange rate unless the management of the relevant
foreign currencies is tracking exactly the same variables.

THE MONETARY POLICY FRAMEWORK OF BANGLADESH BANK:

The monetary policy framework of Bangladesh Bank identifies a logical and sequential set of
actions for designing and conducting the monetary policy. The framework is based on
credible information on the stability of the money demand function, the money supply
process, and the monetary transmission mechanism. Monetary policy in Bangladesh is
framed using projected real GDP growth rate. The targeted rate of inflation adopts Reserve
Money (RM) and Broad money (M2) as operating and intermediate targets respectively.

Monetary policy consists of a set of rules that aim at regulating the supply of money
in accordance with predetermined goals. Monetary policy is important because it can
influence economic growth, inflation, and the balance of payments (BOP). The central bank

conducts monetary policy by using instruments that influence the supply of money and
interest rates in the economy. The fundamental objective of pursuing monetary policy by the
Central bank is to ensure that the expansion in the money supply is consistent with the
objectives of the government policies for economic growth, inflation, and the BOP. In
conducting monetary policy, the central bank tries to ensure that the supply of money is in
line with the amount of money demanded by the economic agents: households and firms. The
main policy goals of monetary policy of Bangladesh Bank are:
1. To achieve sustainable economic growth
2. To maintain price stability
3. To attain sustainable BOP
4. To regulate currency and reserves
5. To manage the monetary and credit system

Monetary Policy Statement (MPS) was first issued by the Bangladesh Bank in January 2006.
The MPS is intended to present for general information on Bangladesh Bank's outlook on real
sector and monetary developments over the immediate future and the monetary policy stance
it pursue, based on its assessment of the developments over the preceding quarters.
The MPS starts with articulation of the monetary policy framework in terms of the goals,
instruments, 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.

The Monetary Policy Statement (MPS) is intended to outline the objective and the modalities
of formulation and conducting of monetary policies by the Bangladesh Bank, 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 the Bangladesh Bank as outlined in the Bangladesh
Bank Order, 1972 comprise attaining and maintaining of price stability, high levels of
production, employment and economic growth.

Policy Instruments:
Repo & reverse repo auctions
Various T-bill auctions
Setting SLR & CRR
Bank rate

Targets:
Operating target
* Reserve money
Intermediate target
* Broad money

Goals:
Sustainable economic growth
Price stability
Sustainable BoP

Information Variables:
Foreign reserves
Short-term interest rate
Liquidity situation
Domestic credit

Policy Decision:
Based on market information
and judgment of policy
markers

Inflation and exchange rate

REQUIRED RESERVE RATIO:

The required reserve ratio is the amount of reserves as a percentage of their deposits that
banks are required to hold. These reserves may be held in the form of cash in the vault or as
deposits with the Bangladesh Bank. Bangladesh Bank can decide whether or not it will pay
interest on these deposits. Changes in reserve requirement affect the money supply by
causing the money multiplier to change. For example: if Bangladesh Bank wants to increase
the money supply, it decreases the required reserve ratio. As soon as it does, deposit money
banks (DMBs) have additional free reserve that they can lend. Because reserves generally
earn no interest, banks will increase their lending until all unutilized reserves are invested in
interest- earning assets. The increase in bank credit increases the money supply. If BB wants
to decrease the money supply, it increases the required reserve ratio. To increase their
reserves, DMBs must decrease their lending. This leads to decline in money supply. The
present reserve requirement ratio of Bangladesh Bank is 23% of which 5% is cash reserve
requirement (CRR) and 18% statutory liquidity reserve (SLR).

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.

DISCOUNT RATE (BANK RATE):

The discount rate is the rate of interest that Bangladesh Bank charges DMBs for credit.
Changes in the discount rate affect the money supply by affecting the volume of discount
loans and the monetary base. A rise in discount loans adds to the monetary base and expands
money supply. Conversely, a fall in discount loans reduces the monetary base and shrinks
money supply. For example, Bangladesh Bank increases the discount rate to money supply.
DMBs pay more for Bangladesh Bank credit. Typically, DMBs will increase the lending rate

charged from the private sector, and the demand for credit by the private sector will decrease.
The current discount rate is 5%.

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).
For controlling the monetary base, Bangladesh Bank carries out open market operations
(OMO). When the central bank engages in open market operations, it buys or sells
government securities, bonds in transactions with DMBs. For example, Bangladesh Bank can
buy or sell government securities in open market operations to change the quantity of money
available. Open market purchases expand the monetary base, thereby raising the money
supply. In a repurchase agreement (often called a repo), Bangladesh Bank purchases
securities with an agreement that the seller will repurchase them in a short period of time. On
the other hand, open market sales shrink the monetary base, lowering the money supply. In a
reverse repo transaction, Bangladesh Bank sells securities and the buyer agrees to sell them
back to the BB in near future.

IMPACTS OF THE OPEN MARKET OPERATIONS

Reverse repo and repo interest rates are BBs 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; open market
operations seem to be the most effective tool. This is because open market operations are the
primary determinants of change in the monetary base. Moreover, they occur at the initiative
of the central bank, are easily reversed, and can be implemented quickly.

MONETARY POLICY IN DEVELOPING COUNTRY:

The monetary policy in a developing economy will have to be quite different from that of a
developed economy mainly due to different economic conditions and requirements of the two
types of economies. A developed country may adopt full employment or price stabilization or
exchange stability as a goal of the monetary policy. But in a developing or underdeveloped
country, economic growth is the primary and basic necessity. Thus, in a developing economy
the monetary policy should aim at promoting economic growth, the monetary authority of a
developing economy can play a vital role by adopting such a monetary policy which creates
conditions necessary for rapid economic growth. Monetary policy can serve the following
developmental requirements of developing economies like Bangladesh.

CONCLUSION:
The key lesson from the Bangladeshi experience is that monetary policy needs to move away
from a narrow price stability/inflation targeting objective as may be warranted by
circumstances. As guardians of financial stability and lenders of last resort, central banks
need to be concerned not only with monetary policy but also with development and
regulation of banks and key financial markets, like money, credit, bond and currency
markets. At the same time monetary authority should be concerned about the current fiscal
policy taking by government.
While price stability remains a key objective, an inflation targeting framework alone is
inadequate because Bangladesh is subject to a number of shocks and special regulatory and
administrative structures not necessarily present in the country. These shocks include supply
shocks from vagaries of the monsoon; large weight of food prices in various consumer price
indices; large fiscal deficits and market borrowings by Bangladesh government; and
impediments to monetary transmission due to administered interest rates in some government
savings instruments.

REFERENCE:
Books:
Frederic S. Mishkin; The economics of Money, Banking, and Financial Markets'" , 7th
Edition. (International Edition: Pearson Book Company, 2008).

Web Sites:
www.mof.gov.bd
www.bbs.gov.bd
www.wikipedia.org/wiki/Economy_of_Bangladesh

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