Economic growth implies the expansion in productive capacity or capital stock in the economy so that an increase in real national output or income is attained.
Economic growth can be speeded up by accelerating the rate of saving and investment in the economy. this requires the following steps;
- Increase in the aggregate rate of savings
- Mobilization of these savings so that they are made available for the purpose of investments and production
- Increase in the rate of investment
- Allocation of investment funds for productive purposes and priority sectors of the economy
Monetary policy and savings
Several monetary measures can be adopted to raise the aggregate level of savings. According to Keynes, the rate of interest represents the cost of the investment; the lower the rate of interest the greater will be the inducement to invest.
This however may not produce the desired results because where inducement to invest may be promoted by lowering the interest rates, the adequate amount of resources or savings needed to finance large amount of investment may not be forthcoming at lower interest rates.
Further a lower interest rate policy in a developing country like Kenya is likely to promote more investment in inventories and luxury consumer goods such as cars, air conditioners, luxury houses, rather than capital goods. The interest rate should therefore be relatively high to induce more savings so that large resources are made available for investment in fixed capital.
Besides, monetary policy can play a strategic role in increasing savings by promoting the expansion of banking facilities and other financial intermediaries in the under developed countries, especially in the rural areas. With more bank branches in under banked and under developed regions, the people who consume away their surplus incomes, will be induced to save them inform of bank deposits which are quite safe as a store of value.
The central bank encourages thrift or propensity to save by offering a return on savings in the form of high interest rates on bank deposits.
It also induces more savings by providing more outlets for fruitful investments of savings by people who would otherwise put them to unproductive or wasteful uses such buying gold and jewelry. In order to facilitate mobilization of an increasing proportion of saving by the banking system, it is essential to maintain a reasonable rate of price stability
Further if banks are to mobilize adequate amount of savings inform of bank deposits, interests’ rates on bank deposit must remain positive in real terms (nominal rate of interest minus inflation). If there is excessive rise in prices, the real rate of interest becomes negative and people will be discouraged to save.
Monetary policy and investment
Monetary policy has an important role to play in boosting up the level of investment by making available saving or resources mobilized by banks for purposes of investment and production. The banks fulfill this by offering credit for investment in business and industry.
It may be noted that the Keynesian theory of monetary policy emphasizes that the effect of a change in money supply on the level of production and investment operates through changes in interest rates.
An increase in money supply by the monetary authority will cause the market rate of interest to fall. At a lower rate of interest, the entrepreneurs will be induced to invest more. However, it has been argued that investment in fixed capital is interest inelastic.
That’s why Keynes did not have much faith in monetary policy effectiveness and instead promoted the role of fiscal policy in influencing economic activity. Recent monetary policy emphasizes the credit availability effect on investment due to changes in money supply.
According to this, an increase in the supply of money which causes the expansion in the reserve money with the bank directly changes the availability of bank credit for investment purposes and therefore raises the level of investment in the economy.
Allocation of Investment Fund
Mobilization of savings alone would not do. Proper allocation of these resources into a suitable direction of investment is more important than mobilization. Monetary policy should restrict the growth of wasteful lines of investment which sre dangerous to economic growth. I
t should be able to direct investment into productive channels. In this regard monetary policy should play a selective and qualitative role in its operations in order to discriminate between productive and unproductive outlays.
It should be designed in such a way that it influences specific sectors and industries which are most significant to affect the growth of the economy.
Therefore, it’s necessary to operate the selective credit rationing with a view of influencing the pattern of investment. This may be done by fixing a ceiling on the aggregate portfolio of the commercial banks, thereby making it incumbent that those loans and advances do not exceed the fixed ceiling. Alternatively, it may be done by directly allocating funds that have been granted.
Measures such as lengthening the period of repayment, lowering of margin requirements, providing rediscounting facilities at rates below the bank rates, provision of special loans to commercial banks to be used for specific purposes are also used.
However, the extent to which such measures can help provide resources for investment in the desired direction depends on the extent to which the flow of credit towards the undesirable channels can be prevented.
Secondly such measures may go a long way in galvanizing the process of growth by restraining inflation and its adverse effects. When inflationary tendencies set in, generally, bank advances to businessmen tend to rise. In this way certain undesirable and unproductive enterprises may grow and flourish.
For instance, activities such as speculative demand for building up inventories, accumulation of precious metals for purchase of foreign exchange get a flip. Growth of such and other unwanted industries can be held in check by raising the margin requirements for their collateral.
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