Unit 12.2GOVERNMENT ECONOMIC POLICY

STRATEGIES

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TOPICS TO BE COVERED

TOPIC 1 : MONEY AND BANKING Bank of Papua New Guinea

Student Activity

TOPIC 2 : MONETARY POLICY Interest Rates Policy

Liquid Assets Ratio

Special Deposits and Moral Suasion

Open Market Operation

Student Activity

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Learning outcomes:On successful completion of this topic, students will be able to:

Explain the functions of Central Bank (Bank of Papua New Guinea) anddifferentiate with commercial banks’ functions

Identify the instruments or tools of monetary policy.

Explain how each instrument can be used to contract or expand the economy.

Describe the aims of monetary policy and state its overall effects on the economy

Distinguish types of monetary policies and their effect on the economy.

How monetary policy instruments are used to control the money supply.

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Timeframe and Instructions•This course will take you four (4) weeks to complete and is

accompanied by worksheets.• If you set an average of 3 hours per day, you should be able to

complete the unit comfortably by the end of the assigned week.•Ask your parents or guardians to help you complete it. The worksheet

should be completed within the given period.•You will have to read the notes before attempting the activities.•The activity is done to check your understanding of the topic.•Please ask your parents to assist you in dropping off your answered

activity at the front office. Alternatively a scanned copy can beemailed to postofficebox@pomgrammar.ac.pg

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TOPIC 1 : MONEY AND BANKING

In our previous lessons we were looking at the,

Definition of Money

Characteristics and Functions of Money

Types of money and

The factors affecting money supply in an economy.

However, for this lesson we will be looking at a new topic that is on the next slide.

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Unit Learning Outcome

By the end of this lesson the students can be able to;

The other name for the Bank of Papua New Guinea

Know the aims of the Central Banks/BPNG

List functions of the Central and Commercial Banks

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TOPIC 1 : MONEY AND BANKING

The Bank of Papua New Guinea (BPNG) is also called the Central Bank

WHAT ARE THE AIMS OF Bank of Papua New Guinea BPNG?Aims to ensure that the nation’s monetary policies are carried out in the most

efficient way

to promote monetary stability and a sound and efficient financial structure.

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What the functions of the central bank (BPNG)

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What are the functions of the commercial bank?

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NOW DO STUDENT LEARNING ACTIVITY 12.1 ON THE NEXT SLIDE.

12.2. 1 Student Learning Activity

1. Distinguish between BPNG and Commercial banks in terms of their ownership and

functions.

2. Is Micro-bank a commercial bank? Explain Why it is regarded as a commercial bank?

3. Give some examples of commercial banks in Papua New Guinea.

4. List six (6) functions of;

Commercial bank

Central bank (BPNG)

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Instruction to candidates:

• You are to complete the activities in your economics exercise book.

In this unit we will discuss the monetary policy carried out by the government through theBank of Papua New Guinea. We will look at how the Bank of Papua New Guinea controls theamount of money in the economy and the way in which that money is being used.

Monetary policies are set by the Central Bank (BPNG) on behalf of the Government. The aim of the monetarypolicy is to control;The amount of money in the economy (money supply), and The way in which that money is used

Instruments(tools/weapons) of Monetary PolicyThese are factors or policies used to achieve the aims of the monetary policy.

1. Interest Rate Policy

2. Liquid Asset Ratio (LGS)

3. Special Deposit (S.R.D.)

4. Open Market Operation (OMO)

5. Control over Lending

6. Moral Suasion

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TOPIC 2 : MONETARY POLICY

Unit Learning Outcome

By the end of this lesson the students can be able to;

Define monetary policy.

identify the instruments or tools of monetary policy.

explain how each instrument can be used to contract or expand the economy.

describe problems encountered in implementing monetary policies in developing countries.

how monetary policy instruments are used to control the money supply.

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Interest Rates PolicyWhat is Interest?It is the payment for the use of money borrowed, payment received for money lent.

• Interest rates are determined by the supply and demand for loanable/lending funds.

What is interest rates?Interest rate is the percentage (%) of interest charged on the amount borrowed (loans). In other words, itis the cost of borrowing. For example, when you borrow from a commercial bank, you pay an extraamount on top of what you borrow.

• The Central Bank simply increases or decreases the interest rate charged by commercial banks onlending to influence money supply in the economy.

Interest rate has an inverse or indirect relationship with lending (borrowing).• Higher interest rate discourages borrowing which leads to reduction in consumption, increased savings

and reduced investment. This results in a decrease in the money supply and thus contracts theeconomy.

• Lower interest rate encourages borrowing which leads to increased consumption and investment. Thisresults in an increase in the money supply thus expending the economy.

The flowchart below shows the effect of higher interest rates on borrowing, lending, consumption, investment, production and employment level in the economy.

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The flowchart on the left shows thatincreased interest rate results inrising cost of borrowing and thuslending (credit) falls. Consequently,less money or financial shortageresults in falling consumption(aggregate demand), investment,production and ultimatelyemployment falls.

Liquid Assets RatioWhat is Liquid Asset Ratio?It is the proportion of the total bank deposits put asidefor meeting customer’s demand for withdrawal. (Therest of the total deposits are for loans and advances).

• For example the total bank deposit is K100m, 40% of the 100m is kept in the bank.

• Increase in LGS ratio reduces the ability of the banks to create credit (loans and advances) and deflates (contracts) the economy. For instance, if 40% has now increased to 50%.

• Decrease in LGS ratio increases the ability of the banks to create credit (loans and advances) and expand the economy. For instance, 40% has decreased to 30%.

• The flowchart on your right shows the effect of increase in LGS (liquid asset and government securities) ratio on liquid asset, loans and advances, aggregate (total) demand, investment, production and unemployment

The flowchart below shows that increase in LGS ratio increases liquid asset portion of the commercial banks and lessen money available for loans and advances. Decreased lending results in fall in demand, investment and production and so increases unemployment

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Special Deposits and Moral Suasion What are Special Deposits?

Commercial banks are required to hold acertain percentage of their deposits as specialdeposits’ with the Central Bank. This SpecialDeposit is not available for lending. SpecialDeposits are also called Statutory ReserveDeposits (SRD) in other countries.

Imposing or increasing special deposit candecrease lending and be used as part of apolicy to deflate (contract) the economy.

Abolish or decreasing special deposit canincrease the ability of commercial banks toincrease lending and stimulate (expand) theeconomy. This policy is not widely used inPNG.

The flowchart below shows the effect of imposing or increasing special deposit on lending, aggregate demand, investment, production and unemployment level.

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Moral SuasionWhat is Moral Suasion?

This refers to the mutual co-operation between theCentral Bank and commercial banks in implementingthe monetary policies set by the Central Bank.

For instances, Central Bank may persuade thecommercial banks to reduce interest rates to increaselending in order to stimulate the economy and thecommercial banks cooperating in implementing thepolicy.

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Open Market Operation (OMO)

What is Open Market Operation?

This refers to buying and selling of governmentsecurities (treasury bills/bonds and governmentinscribed stocks) as an instrument of monetarypolicy.

What are government Securities?Government securities are simply a piece of an officialdocument (paper) sold by the government. Thegovernment agrees to buy back the governmentsecurities on a certain date and pays an agreed rate ofinterest. In PNG, most government securities are boughtby the banks, and become part of their liquid assets(therefore, their liquid asset ratio includes liquid assetsand government securities).

• Selling government securities reduces money supplyand contracts the economy and vice versa,

• Buying back government securities increases moneysupply and expands the economy.

• The flowchart below shows the effect of selling government securities on lending, consumption, investment, production and unemployment level.

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• The flowchart above shows that when the central bank (BPNG) on behalf of thegovernment sells government securities, the commercial banks buy most of it.The commercial banks use the money supposed to be for lending to borrowers topurchase government securities and so reduces their lending. Reduced lendingresults in individuals and firms having less money or facing financial problem soresults in decreased demand, investment, production and ultimately laying offemployees resulting in increased unemployment.

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YOU HAVE COME TO THE END OF TOPIC 2.

NOW DO STUDENT LEARNING ACTIVITY 12.2 ON THE NEXT PAGE.

Open Market Operation (OMO)

Student Learning Activity 12.2.2

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Student Learning Activity 12.2.2

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Reference Source

• Flexible, Open and Distance Education,PNG. 2017

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