loses its value and the price of goods go up. Excess money chasing the few products in the market thereby forcing sellers to increase the prices for their goods; this situation is called INFLATION.
On the other hand, if there is a minimal amount of cash in the economy the value of our currency will be too high, and the price of goods will fall down to the extent that sellers may no longer be on the edge of making profit forcing them to leave the market. In this case, there will be little cash wishing to buy plenty products in the market, so in order to sell you have to reduce the price at which you sell. Sometimes it gets to a point that the seller no longer makes any profit and will have to leave the market. This is called DEFLATION.
Because of these two extremities the government through the central bank will have to control the amount of money in circulation in the country to avoid these extreme situations. It’s as simple as, if you eat too much food, you will get too fat; if you eat too little food you will be thin, so our parents will have to control the amount of food they give us to keep us healthy.
Monetary policies are in two forms, EXPANSIONARY and CONTRACTIONARY.
An Expansionary Policy is a measure that the CBN takes to increase the money in circulation in the Economy when there is too much cash in the country's economy while the Contractionary Policy is meant to reduce the money in circulation in the economy when there is too little cash in the economy.
This year, the Central Bank of Nigeria is adopting a Contractionary policy to reduce the amount of money in circulation.
The CBN can do this in several ways.
1. Open Market operations
2. Liquidity ratio
3. Cash reserve ratio
4. Bank rates.
5. Moral suasion
These methods and how Nigeria is presently using them will be discussed in subsequent posts. What's your take on this?
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