Abstract

The Central Bank is the highest authority employed by the government for formulation of
monetary policy to guide the economy in a certain country. Monetary policy is defined as
the regulation of the money supply and interest rates by a central bank. Monetary policy
also refers to how the central bank uses interest rates and the money supply to guide
economic growth by controlling inflation and stabilizing currency. Like any other central
bank, Bangladesh Bank is performing the role to formulate monetary policy in Bangladesh.

This Assignment analyses the different statistical economic data relating to money supply.
To get the outcome of the study determinants of money supply, monetary base and money
multiplier have been explained. Basically the trend, behavior of the determinants shows
that net foreign assets, net domestic assets, interest rate spread, government borrowing have
a greater impact on money supply process in Bangladesh. It is revealed here that changes
of broad money, monetary base and money multiplier are not proportionally acting in
targeting and achieving money supply. The prudent consideration addressing the matters
may helpful for Bangladesh Bank for adopting and implementing effective monetary policy
and sustainable growth in economy.

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INTRODUCTION

Different macroeconomic policies lay critical roles in developing sustainable economic

stability in a country, which create the environment for the faster economic growth.
Monetary and fiscal policies are the fundamental components for promoting sustainable
growth in the economy. The successful functioning of an economy depends on the
coordinated activities of monetary and fiscal policies and the absence of this coordination
leads to a poor overall economic performance. These policies are conducted by two
separate authorities, they are mutually dependent, and therefore, it is extremely important
to accomplish a consistent and sustainable policy-mix framework. Such framework can
ensure harmonized monetary and fiscal policy and avoid possible inconsistencies.

Fiscal policy deals with the public expenditures and revenues. Pragmatic and sustainable
fiscal stance promotes economic growth without inflation pressure, low levels of fiscal
deficit and public debt, narrow down budget imbalances in situations of high fiscal deficit
and public debt, etc.. Forward-looking governments participate in almost every part of
social and economic life through the fiscal policy. The fiscal policy measures are taken by
influencing aggregate demand and supply, attempting to create better employment
conditions and acceptable inflation level, leading the policy of steady trade balance and
supporting sustainable economic growth.

Monetary Policy deals with the discretionary control of money supply by the central bank.
It is mostly focused on achieving stability of prices through targeting inflation rates,
stimulating exchange rate leading towards positive balance of payment, and acceptable
level of employment. Additionally, it influences the output level and economic growth rate,
and moderates excessive aggregate liquidity in the economy.

Both monetary and fiscal policies have been proved to have roles in the economic
stabilization within developing countries. However, the Keynesians and the Monetarists
have had focused debate over the usefulness of these policies. The monetarists consider
monetary policy to have greater influence on economic activity and the Keynesian believe
that this is the case with fiscal policy. Generally, there are certain situations where

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monetary policy is effective and others in which fiscal policy achieves better
macroeconomic performance.

This research has been conducted to test the comparative efficiency of monetary and fiscal
policy in Bangladesh through the stationary test by using Augmented Dickey Fuller
Method. Firstly, will clarify the monetary and fiscal policy interactions, Secondly, their
influence on the economic growth, and thirdly, we will focus on the review of prior
empirical studies. Special consideration will be given to data used for empirical
investigation. The rest of the paper is dedicated to the model specification, discussion of
the obtained result and conclusion.

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The Money Supply

The money supply is the total amount of money present in a country’s economy – all its
money. There are several ways of measuring this, from the narrow definition (narrow
money), which is classified as M0 or M1, to the broad definition (broad money), which
may be classified as M2, M3 or M4.

A country’s money supply is recorded and published periodically, usually by the central
bank or the government.

Economists, business people, financiers, investors, politicians and public employees

closely monitor changes in the money supply, because it can impact inflation levels, the
exchange rate, and the business cycle (the shift from economic growth to contraction, and
vice-versa).

Definition of Monetary Policy

Monetary policy is the term used by economists to describe ways of managing the supply
of money in an economy.

The actions of a central bank, currency board or other regulatory committee that determine
the size and rate of growth of the money supply, which in turn affects interest rates.
Monetary policy is maintained through actions such as increasing the interest rate, or
changing the amount of money banks need to keep in the vault. (By Geoffrey St.
Marie,2011)

Monetary policy includes all monetary decisions and measures irrespective of whether their
aims are monetary and non-monetary, all non-monetary decision and measures that aim it
affecting the monetary system.( Paul Einzig, 2008)

Monetary policy employing the central bank’s control of supply of money as an instrument
for achieving the objectives of general economic policy. (Harry G. Johnson,2008)

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Significance of Monetary Policy

The Monetary Policy has a great significance on economy. Some of there are as follows.

i) To control supply of money

ii) To Setup rate of interest.

iii) To promote economic growth & stability.

iv) To stabilize price & low unemployment.

v) To control inflation & deflation.

Tools of Monetary Policy Generally Used

Monetary policy tools are as follows

a) Monetary base

Monetary policy can be implemented by changing the size of the monetary base. Central
banks use open market operations to change the monetary base. The central bank buys or
sells reserve assets (usually financial instruments such as bonds) in exchange for money
on deposit at the central bank. Those deposits are convertible to currency.

b) Reserve requirements

The monetary authority exerts regulatory control over banks. Monetary policy can be
implemented by changing the proportion of total assets that banks must hold in reserve
with the central bank. Banks only maintain a small portion of their assets as cash available
for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans.
By changing the proportion of total assets to be held as liquid cash, the Federal Reserve
changes the availability of loan able funds. This acts as a change in the money supply

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c) Discount window lending

Discount window lending is where the commercial banks, and other depository institutions,
are able to borrow reserves from the Central Bank at a discount rate. This rate is usually
set below short term market rates (T-bills).It is of note that the Discount Window is the
only instrument which the Central Banks do not have total control over.

d) Interest rates

The contraction of the monetary supply can be achieved indirectly by increasing the
nominal interest rates. Monetary authorities in different nations have differing levels of
control of economy-wide interest rates. . By raising the interest rate under its control, a
monetary authority can contract the money supply, because higher interest rates encourage
savings and discourage borrowing. Both of these effects reduce the size of the money
supply.

e) Currency board

A currency board is a monetary arrangement that pegs the monetary base of one country to
another, the anchor nation. As such, it essentially operates as a hard fixed exchange rate,
whereby local currency in circulation is backed by foreign currency from the anchor nation
at a fixed rate. Thus, to grow the local monetary base an equivalent amount of foreign
currency must be held in reserves with the currency board. This limits the possibility for
the local monetary authority to inflate or pursue other objectives.

f) Unconventional monetary policy at the zero bound

Other forms of monetary policy, particularly used when interest rates are at or near 0% and
there are concerns about deflation or deflation is occurring, are referred to as
unconventional monetary policy. These include credit easing, quantitative easing, and
signaling. (Monetary Policy”. Federal Reserve Board. January 3, 2006.)

Bodies of Monetary Policy

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With the recommendation of World Bank/IMF, government in 2003 provided the degree
of autonomy to the bank to carry out its responsibilities without undue interference of the
government and a new body, called co-ordination Council.

This council consists of the following governing body

Minister of Finance

Minister of Commerce

Governor of BB

Secretary of Finance Division

Secretary of Internal Resource Division

Member Planning Commission

Source: General Banking by L.R. Chowdhury

This council headed by Minister of Finance with Minister of commerce, Governor of

Bangladesh Bank, Security of Finance divisions, Secretary of internal resource division,
Member of Planning commission as the members has been set up to oversee the
Bangladesh Bank’s Monetary Policies. (General Banking by L.R. Chowdhury)

Monetary Policy Decision- Making Process

The MPC sets monetary policy that is consistent with domestic economic conditions to
ensure price stability and sustainable economic growth. In addition, the MPC plays an
important role in determining guidelines for exchange rate policy that is consistent with
the monetary policy stance. Approximately every six weeks ( 8 times a year), the MPC
needs to assess the economic and financial condition as well as the risk factors that may
affect future inflation and economic growth in its consideration of monetary policy
direction. In each meeting the MPC secretariat presents the latest economic data on
financial market conditions, fiscal position, international financial environment, and

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production, as well as other factors that may affect the price level, including world
commodity prices and US interest rates. The plausible trends of these variables are widely
discussed and subsequently incorporated into the inflation and GDP forecasts.

The Bangladesh Bank undertakes open market operations to ensure that the policy rate is
held- as close as possible- to the level determined by the MPC. Each quarter, the
Bangladesh Bank publishes a quarterly inflationary report to present the latest economic
and inflation forecasts to the MPC in a clear and forward looking manner, as well as
communicates to the general public views of the MPC to in reaching their various policy
decisions. (Bangladesh Economic Review 1999, Ministry of Finance, Government of
Bangladesh.)

Monetary Policy: Bangladesh Experience

Background of monetary policy in Bangladesh

The policy adopted by the central bank for control of the supply of money as an instrument
for achieving the objectives of general economic policy. As stated in the Bangladesh Bank
order 1972, the principal objectives of the countries monetary policy are to regulate
currency and reserves. To manage the monetary and credit system; to preserve the par
value of domestic currency ; to promote and maintain a high level of production,
employment and real income ; and to foster growth and development of the country’s
productive resources in the best national interest. Although the long term focus of
monetary policy in Bangladesh is on growth with stability, the short term objectives are
determined after a careful and realistic appraisal of the current economic situation of the
country.

With the shift of the policy stance of the government in various phases, necessary
adjustments were made in the country’s monetary policy in the first year after liberation,

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the primary target of monetary policy was to regulate not the quantity of money, but the
direction of the flow of money and in support of the government financial programmed. In
1975, Bangladesh entered in to a standby-arrangement with IMF and the country’s
monetary policy got a changed shape, which fixed an explicit target to save limit of
monetary expansion on annual basis, with this change, Bangladesh Bank started setting
short-term objectives of monetary policy in close collaboration of the government and tried
to achieve the target by using the direct instrument of control. The principal target of
monetary control was broad money (M2) i.e., the sum of the currency in circulation and
the total deposits of money in banks. The targeted growth of M2 depended on a realistic
forecast of the growth rate of real GDP, an acceptable rate of inflation and an attainable
level of international reserve.

Bangladesh Bank took majors to monitor credit and monetary expansion keeping in view
the price situation and international reserve position. Efforts were made to achieve the
targeted growth of domestic credit and thereby, the money supply, through imposing
ceiling on credit to the government, public and private sector. The major policy instrument
available to Bangladesh Bank and provide liberal refinance facility at confessional rate for
priority lending. According to the national economic policy, the Banks were to provide the
desired volume of credit t and administered and low rate of interest. In that situation,
Bangladesh Bank practically did not have any effective instrument for making adjustment
in the growth of money supply or for transmitting market signals into changes in money
supply. The monetary policy therefore, could not function in true sense as a result the
banking system could not play its role as an effective financial intermediary. (Central
Banking in the New Millenium.” Ahluwalia,)

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The Methods of Credit Control

The methods of credit control can be classified as follows

Quantitative Methods

i)Bank rate policy

ii) Open market policy

iii)Variation of reserve ratio

Qualitative Methods

i) Rationing of credit

ii) Direct action

iii)Regulation of consumers’ credit

iv)Moral persuasion

v)Publicity

The methods of credit control are described below

Quantitative Methods

The methods by which Central Bank controls the total amount of credit in the economy are
termed as quantitative methods of credit control.

a) Bank rate policy

The rate which central bank lends money to the commercial banks and discounts bill of
exchange is called bank rate. If central bank increases the bank rate then the commercial
banks will increase their marker of interest rates. As a result the borrowers borrow less

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form commercial banks and amount of credit reduces in the economy. In an opposite way
amount of credit will be increased in the country.

Effects

Effects on price level: If bank rate increases, cost of credit will increase and the
businessmen will reduce their borrowing s form commercial banks. This will reduce
production and increase unemployment in the economy. As a result, income and price level
will go down and depression in business and trade will be the outcome. If there is a decrease
in the bank rate the opposite e results of above will be experienced in the economy.

Effects on foreign trades: An increase in bank rate wills increases other interest rates in
the country. So, investment will be profitable. It will ensure the insertion of foreign capital
into the economy and leakage of domestic capital will be stopped. Moreover, increased
bank rate will decrease the piece level because amount of credit will be reduced into
country. This decreased price level will again encourage expert and discourage import,
which will make balance of payment favorable. Opposite effects of above will be
experienced if the central bank decreases the bank rate in the economy.

Limitations of Bank rate policy

i) Bank rate policy would not be effective if there lacks strong linkage between bank rate
and market/ interest rate especially for a developing country like Bangladesh.

ii) If commercial banks have excessive money; then bank rate may not be effective because
they will lend in lower interest rates though bank rate increases.

iii) Bank may successes during the time of prosperity. Because businessmen become highly
ambitious of their profits in this situation and will borrow money though the interest rate
increases.

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iv) Reduction in bank rate may not be successful to increase the amount of credit during
the time of depression. So, bank rate policy has several limitations in its operation. After
that it is the best weapon of central bank to control the amount of credit in the economy.

b) Open market policy

The method by which the central bank controls the amount of credit by selling and buying
government credit instrument is termed as open market operation. When the central bank
intends to contract credit, it sales the credit instruments in the market. These instruments
are purchased by commercial banks and people also buy them issuing cheque to the
commercial banks. Thus money goes to the central bank and amount of money for credit
creation reduces which in turn contracts the amount of credit in the economy.

Limitations of open market policy

i) Selling- it reduces amount of cash of commercial banks .but if commercial banks take
loan form central bank it would not be effective to reduce credit.

ii) Buying- it increases the amount of cash in commercial banks. But it may not be able to
expand credit if commercial banks repay loan to the central bank with this increased cash.

iii) Depreciation- During depreciation credit expansion through purchasing credit

instruments is not possible. Because in this period businessmen will not want tomorrow
from commercial bank.

c) Variation of reserve ratio

Each commercial bank has to keep legally a certain portion of its total deposits as reserve
with central bank. This is called reserve ratio. If central bank increases this reserve ratio,
excess reserve in commercial banks will reduce and thus credit creation will be contracted
in the economy. In an opposite way central bank can increase the amount of credit by
decreasing the reserve ratio.

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Limitations

i) Increase in reserve ration can be effective for that commercial bank having small amount
of cash. Because bank having large volume of cash will have sufficient excess reserve to
create credit though reserve ration increases. In this case it will not be effective.

ii) Decrease in reserve ration may not be effective to expand credit during depression
businessmen are discouraged to borrow in this situation.

iii) Non-scheduled commercial banks are out of this control.

Qualitative Methods

The methods used to control credit in special sectors for special purposes are called
qualitative\selective methods of credit control. These methods do not deal with the amount
of credit rather change the flow or direction of credit used in different sectors of economy.

a) Rationing of credit

Rationing of credit means fixing the amount of credit among different sectors of the
economy. By this method central bank can decrease the amount of credit in one sector and
can increase it in other sector. For example, if central bank thinks that there is excessive
investment in garments industry and jute industry suffers form required investment, then it
can order the commercial banks not to disburse credit beyond required amount in garments
industry and divert the excess amount to jute industry.

Limitations

i) Borrowers may use the credit money in other purposes.

ii) It is difficult for central bank to supervise whether the credit money is being used
purposively or not.

iii) Sometimes commercial banks think this type of work as an unwanted intervention by
central bank.

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b) Direct action

If it is proved by central bank that credit creation policy of any commercial bank is not
transparent then central bank can take punitive measures against that bank and thus affects
its credit creation. These punitive measures may be of not rediscounting bills of exchange,
discounting bills of exchange at a rate higher than the prevailing rare, etc. As a result, the
commercial bank will compelled to follow sound central bank policy.

c) Regulation of consumers’ credit

It is a method to control credit in consumable goods, which are purchased in installment

basis. If central bank circulates to increase the amount of down payment or reduce the
number of installment then consumer’ credit will be contracted in the economy. In an
opposite way consumers’ credit can be increased. It was followed in USA during Korean
War.

d) Moral persuasion

To make the banking system sound and efficient, central bank sometimes requests the
commercial banks to increase or decrease credit. As a guardian’s request, commercial
banks follow it and thus amount of credit is controlled in the economy.

e) Publicity

Sometimes central bank applies publicity as a weapon of credit control. Central bank
publishes weekly, fortnightly or monthly bulletins and annual reports where balance sheets
and other business and economic condition of different commercial banks are presented
well. As a result the commercial banks become more careful in the line of their credit
creation. Thus central bank applies various types of measures to control credit in the
economy. But central bank should apply different types of method simultaneously rather
to use single method to make credit control effective. (Bangladesh Bank Working Paper
Series: WP 0708, 2007)

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In dire economic times, central banks can take open market operations a step further and
institute a program of quantitative easing. Under quantitative easing, central banks create
money and use it to buy up assets and securities such as government bonds. This money
enters into the banking system as it is received as payment for the assets purchased by the
central bank. The bank reserves swell up by that amount, which encourages banks to give
out more loans, it further helps to lower long-term interest rates and encourage investment.
After the financial crisis of 2007-2008, the Bank of England and the Federal Reserve
launched quantitative easing programs. More recently, the European Central Bank and the
Bank of Japan have also announced plans for quantitative easing.

The Money Supply Process in Bangladesh

The key players in the money supply process as follows:

1. The Central Bank- The government agency that oversees the banking system and is
responsible for the conduct of monetary policy; in Bangladesh, it is Bangladesh Bank.

2. Banks (depository money banks (DMBs)) - The financial intermediaries that accept
deposits from individual and institutions and make loans: commercial banks, savings and
loan associations, mutual savings banks and credit unions.

3. Depositors- individuals and institutions that hold deposits in banks. Of the three
players, the central bank in Bangladesh, Bangladesh Bank is the most important. The
conduct of monetary policy by Bangladesh Bank involves actions that affect its balance
sheet (holding of assets and liabilities) to which we turn now.

The Central Bank’s Balance Sheet:

In order to understand the dynamics of money supply process in Bangladesh, the balance
sheets of the central bank, depository money banks (DMBs) and the monetary survey of
the banking system need to be studied.

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Net foreign assets include the following items:

• On the assets side, official international reserves (including gold, foreign exchange, the
reserve position of the country in the IMF, and holdings of special drawing rights);

• On the liability side, short-term liabilities to foreign central banks, including their
deposits, swap facilities, overdrafts, and some medium and long-term debt; such as the
country’s use of IMF credit; and

Other foreign assets and liabilities not included in the definition of official reserves. Net
domestic assets include both net domestic credit and other items, net. Net domestic credit
comprises several claims: net claims on the government, claims on DMBs, and claims on
other domestic sectors.

Let us now turn to the liabilities side of the balance sheet:

Reserve money is sometimes called high powered money, base money, or the

Monetary base. It includes the following core items:

• Currency in circulation (the amount of currency in the hands of the public);

• Reserves of DMBs with the central bank. Reserves consists of their deposits at the
central bank plus currency that is physically held by banks (called vault cash).

Reserve money excludes:

• The government’s deposit with the central bank; and

• Central bank liabilities to non-residents.

Currency in circulation depends on the asset side of the balance sheet and is a liability to
the central bank. The total assets always be equal to the liability as per accounting
principles.

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The Monetary Base:

Reserve money or the monetary base, also called “high powered money” consists of:

C Currency in the hand of the public

+R + Reserves of the banking system (Reserves of Depository Money
Banks (DMBs) with the central bank. Reserves consist of their
deposits at the central bank plus currency that is physically held by
banks called vault cash).
MB = Monetary Base

The term ‘high powered’ refer to the fact that an increase in the base money by Tk. 1
creates, through the money multiplier, an increase of more than Tk. 1 in money supply.
Monetary base is typically the monetary liabilities of the central bank.

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Contributions to the Growth of M2 Supply:

Column1 Column2 Column3 Column4 Column5 Column6 Column7 Column8 Column9 Column10 Column11
2006-2007 2007-2008 2008-2009 2009-2010 2010-2011 2011-2012 2012-2013 2013-2014 2014-2015
Assets
Net
Foreign
Assets
(in Crore
Tk.) 9234 13591 15913 18229 21525 32397 37318 47459 67074

Net
Domestic
Assets
(in Crore
Tk.) 89022 100226 113391 132780 158663 178616 211950 249040 295958
Liabilities
Broad
Money
( in crore
Tk.) 98256 113817 129304 151009 180188 211013 249268 296500 363031
Contribution to M2 growth
Change
in net
foreign
assets
(%) 29.1 47.2 17.1 14.6 18.1 50.5 15.2 27.2 41.3
Change
in net
domestic
assets
(%) 11.71 12.59 13.14 17.1 19.49 12.58 18.66 17.5 18.84
Change
in Broad
Money
(%) 13.13 15.59 13.8 16.75 19.3 17.06 17.63 19.17 22.44

The growth of net foreign assets (NFA) and net domestic assets (NDA) work as the
driving forces behind the growth of money supply (M2) over the time. In the time series
data contribution of NFA was negative in the FY95-96, FY96-97, and FY98-99 and in
FY 2000-01.In which the most negative contribution to money supply was (-) 35.9
percent in FY 95-96. On the other hand, NDA has a moderate changes over the period
and had a great contribution on money supply in FY95-96 at 22.63 percent which was the
highest contribution on money supply as percent. NFA has the highest contribution at
50.5 percent in the FY 2011-2012. The other biggest contribution on money supply was
47.2 percent and 41.3 percent in FY 2007-2008 and 2014-2015 respectively, while the

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NDA was 12.59 percent and 18.84 percent during the fiscal years. This was happened
mainly due to the growth of NFA of Bangladesh Bank which attained 54.25 percent,
63.33 percent and 41.53 percent in those fiscal years.

Though NFA has a fluctuating trend and the changes of NDA were almost consistent over
the period, the broad money (M2) has got an upward trend. But whatever the changes
encountered in NFA and NDA, M2 increased over the time since 2006-07 to 2014-15. In
FY 2014-15, M2 has recorded a robust growth of 22.44 percent which was 19.17 percent
over the previous fiscal year. Of which NFA has a great contribution at 41.3 percent during
FY2014-15.

Bangladesh Foreign Exchange Reserves:

Foreign Exchange Reserves in Bangladesh increased to 33226.90 USD Million in

December from 32623.90 USD Million in November of 2017. Foreign Exchange
Reserves in Bangladesh averaged 17964.65 USD Million from 2008 until 2017, reaching
an all-time high of 33596.30 USD Million in August of 2017 and a record low of 7470.90
USD Million in June of 2008.

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Deposit Interest Rate:

Deposit Interest Rate in Bangladesh decreased to 8.20 percent in 2015 from 9.08 percent
in 2014. Deposit Interest Rate in Bangladesh averaged 9.60 percent from 1980 until 2015,
reaching an all time high of 12.05 percent in 1991 and a record low of 6.04 percent in
1995.

Bangladesh Money Supply (M0, M1, M2, M3):

M0:

M0 is the most liquid measure of the money supply including coins and notes in
circulation and other assets that are easily convertible into cash. Money Supply M0 and
M1, are also known as narrow money. Money Supply M0 in Bangladesh increased to
1406.87 BDT Billion in December from 1382.41 BDT Billion in November of 2017.
Money Supply M0 in Bangladesh averaged 358.02 BDT Billion from 1990 until 2017,
reaching an all time high of 1591.99 BDT Billion in August of 2017 and a record low of
34.38 BDT Billion in November of 1990.

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M1:

Money Supply M1 in Bangladesh increased to 2337897 BDT Million in December from

2270919 BDT Million in November of 2017. Money Supply M1 in Bangladesh averaged
379118.37 BDT Million from 1974 until 2017, reaching an all time high of 2434033
BDT Million in August of 2017 and a record low of 6267 BDT Million in April of 1975.

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M2:

Money Supply M2 in Bangladesh increased to 10559.99 BDT Billion in December from

10403.65 BDT Billion in November of 2017. Money Supply M2 in Bangladesh averaged
2609.98 BDT Billion from 1990 until 2017, reaching an all-time high of 10559.99 BDT
Billion in December of 2017 and a record low of 207.37 BDT Billion in March of 1990.

M3:

Money Supply M3 in Bangladesh increased to 12353084 BDT Million in June from

11872800 BDT Million in May of 2017. Money Supply M3 in Bangladesh averaged
4188793.51 BDT Million from 1999 until 2017, reaching an all time high of 12353084
BDT Million in June of 2017 and a record low of 732982 BDT Million in February of
1999.

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Bangladesh Loans to Private Sector:

Loans to Private Sector in Bangladesh increased to 7948.55 BDT Billion in December

from 7776.32 BDT Billion in November of 2017. Loans to Private Sector in Bangladesh
averaged 1752.36 BDT Billion from 1990 until 2017, reaching an all time high of
7948.55 BDT Billion in December of 2017 and a record low of 152.33 BDT Billion in
July of 1990.

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The Bottom Line

Central banks work hard to ensure that a nation's economy remains healthy. One way
central banks do this is by controlling the amount of money circulating in the economy.
They can do this by influencing interest rates, setting reserve requirements, and employing
open market operation tactics, among other approaches. Having the right quantity of money
in circulation is crucial to ensuring a healthy and sustainable economy.

Significance of the Study

The study is very relevant as it will empirically show the impact of fiscal and monetary
policies on economic growth in Bangladesh. However it is important to study the effect of
the two policies to ensure the growth of real gross domestic product (RGDP). Thus, the
purpose of this study is to fill the gap by testing the effectiveness of two policy variables
on RGDP in the case of less developed country like Bangladesh. This will also help the
government to establish policy mix to boost economic growth and development.

Challenges & Recommendation

Key Challenge for Monetary Policy of Bangladesh

The challenges of monetary policy in Bangladesh are as follows

1. There Exist a Non-Monetized Sector

In Bangladesh there is a existence of non-monetized economy in large extent people areas

where many of the transaction are of the barter type and not monetary type .similarly ,due
to non-monetized sector the progress of commercial banks is not up to mark ,this creates a
major bottleneck in the implementation of the monetary policy in Bangladesh.

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2. Excess Non-Banking Financial Institutions (NBFI)

As the economy launch itself into a orbit of economic growth and development,the
financial sector comes up with great speed as a result many non banking financial
institutions (NBFI) come up ,these NBFIs also provide create in the economy ,however the
NBFIs is do not come under the purview of a monetary policy and thus nullify the effect
of a monetary policy.

3. Existence of Unorganized Financial Markets

The financial markets help in implementing the monetary policy ,in many developing
countries the financial markets especially the money markets are of an unorganized nature
and in backward conditions ,in many places people like money lenders ,traders ,and
business actively take part in money lending ,but unfortunately they don’t not under the
purview of a monetary policy and creates hurdle in the success of a monetary policy

4. Higher Liquidity Hinders Monetary Policy

In rapidly growing economy the deposit base of money commercial bank is expanded, this
creates excess liquidity in the system .under this circumstance even if the monetary policy
increase the CRR or SLR, it does not deter commercial banks from credit creation ,so the
existence of excess liquidity due to high deposit base is a hindrance in the way of successful
monetary policy.

5. Money Not Appearing In an Economy

Large percentage of money never comes in the mainstream economy, rich people, traders
,business and other people prefer to spend rather than to deposit money in the bank ,this
shadow money is used for buying precious metals like gold silver ,ornaments ,and land and
in speculation ,this type of lavish spending give rise to inflation trend in mainstream
economy and the monetary policy fails to control it.

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6. Time Lag Affects Success of Monetary Policy

The success of the monetary policy depends on timely implementation of it ,however ,in
many cases unnecessary delay is found in implementation of the monetary policy ,or many
times timely directives are not issued by the central bank , then the impact of the monetary
policy is wiped out.

7. Monetary and Fiscal Policy Lacks Coordination

In order to attain a maximum of the above objectives ,it is unnecessary that both the fiscal
and monetary policies should go hand ,as both these policies are prepared and
implementation by two different authorities ,there is a possibility of non-coordination
between these two policies ,this can harm the interest of the overall economic policy.

Print More Money

As no economy is pegged to a gold standard, central banks can increase the amount of
money in circulation by simply printing it. They can print as much money as they want,
though there are consequences for doing so. Merely printing more money doesn’t affect
the output or production levels, so the money itself becomes less valuable. Since this can
cause inflation, simply printing more money isn't the first choice of central banks.

Set the Reserve Requirement

One of the basic methods used by all central banks to control the quantity of money in an
economy is the reserve requirement. As a rule, central banks
mandate depository institutions to keep a certain amount of funds in reserve against the
amount of net transaction accounts. Thus a certain amount is kept in reserve, and this does
not enter circulation. Say the central bank has set the reserve requirement at 9%. If
a commercial bank has total deposits of $100 million, it must then set aside $9 million
tosatisfy the reserve requirement. It can put the remaining $91 million into circulation.

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Influence Interest Rates

In most cases, a central bank cannot directly set interest rates for loans such as mortgages,
auto loans, or personal loans. However, the central bank does have certain tools to push
interest rates towards desired levels. For example, the central bank holds the key to the
policy rate—this is the rate at which commercial banks get to borrow from the central bank
(in the United States, this is called the federal discount rate). When banks get to borrow
from the central bank at a lower rate, they pass these savings on by reducing the cost of
loans to its customers. Lower interest rates tend to increase borrowing, and this means the
quantity of money in circulation increases.

Engage in Open Market Operations

Central banks affect the quantity of money in circulation by buying or selling government
securities through the process known as open market operations (OMO). When a central
bank is looking to increase the quantity of money in circulation, it purchases government
securities from commercial banks and institutions. This frees up bank assets—they now
have more cash to loan. This is a part of an expansionary or easing monetary policy which
brings down the interest rate in the economy. The opposite is done in a case where money
needs to taken out from the system. In the United States, the Federal Reserve uses open
market operations to reach a targeted federal funds rate. The federal funds rate is the
interest rate at which banks and institutions lend money to each other overnight. Each
lending-borrowing pair negotiates their own rate, and the average of these is the federal
funds rate. The federal funds rate, in turn, affects every other interest rate. Open market
operations are a widely used instrument as they are flexible, easy to use, and effective.

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Conclusion

The recent global financial turmoil creates some negative impact on banking system,
foreign remittance anticipating to be reduced, foreign investment may be declined,
domestic capital mobilization may be interrupted that may affect the RM as well as money
supply in Bangladesh. In the meantime government has declared financial package to
recover the financial sector and the foreign exchange earnings sectors. Also government is
trying to bring black money on the track of real economy. All these effort will help to keep
the GDP growth as intended and Bangladesh Bank will be able to control the inflation and
be able to keep steady growth rate of broad money and sustainable growth of the economy.

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