Tools of monetary policy

Tools of monetary policy

• 1.
  Monetary policy
• 2.
  Monetary policy isthe macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like  Inflation  Consumption  Growth  Liquidity.
• 3.
  Tools of monetarypolicy:  Also known as instruments of monetary policy.  The objectives of monetary policy can be achieved successfully if these instruments are properly coordinated
• 4.
  Bank rate policy: Bank rate is the discount rate set by the central bank of every country in giving out loans to commercial banks through bills of exchange.  Bank rate and interest rate are two different things.  There is a positive or direct relation between bank rate and interest rate.  During inflation, the central bank increases the bank rate.  During depression, the central bank decreases the bank rate.
• 5.
  Open market operation: Using this instrument central bank may influence money supply of country directly by the sale and purchase of securities in the stock exchange.  During inflation it is the duty of the central bank mainly to ensure that the volume of credit and money supply in the country in cut down.  Whenever, the government want to increase the volume of credit, the central bank then purchases the securities from commercial banks and people in general upon which payment is made through cheques.
• 6.
  Changes in ReserveRatio: Through this policy the central bank determines that a certain proportion of cash deposit from commercial banks is to be deposited with it ( central bank ) so that the central bank by this way influences the volume of credit in country Example in Pakistan a total of 5 % cash is to be kept against demand and time deposits in the central bank. If the central bank wants to reduce money supply it increases the reserve ratio requirement. If the central bank wants to increase money supply it decreases the reserve ratio requirement.
• 7.
  Credit Rationing  Thefirst three tools of monetary policy are the quantitative credit control measures and thus fort instrument will only be practiced if all the previous measures have failed to bring about the desired result  By credit rationing the central bank fixes the credit ceiling allowed for each and every commercial bank and will not give further credit to them beyond limit allowed.
• 8.
  Moral Suasion  Bythis qualitative measure the central bank morally persuades or rather requests the commercial banks not to indulge themselves in such economic activities which may well aggravate the current economic situation in the country.  Morally word means here that the central bank issues directions to the commercial banks giving logical reasons.
• 9.
  Direct Action: This methodof control will only be applied when the previous method has failed. As, it is now assumed that commercial banks have now become a threat to the policy, in spite of moral suasion i-e they continue to give loans as usual and thus the central bank is forced to take direct action against these commercial banks.
• 10.
  Publicity:  From timeto time central bank publishes details concerning commercial banks.  The central bank refers to such measure specially when the inflation period is getting worse.  The reason for central bank doing this is to keep the public aware of the commercial banks activities so that the people actually know to what and where their money has gone.
• 11.
  Changes in MarginRequirements: Marginal requirement is the percentage difference between the value of the collateral against the loan and the amount of loan given itself to the borrower by commercial banks Example The collateral is 100 and the loan given by the bank is 75. thus by this way we can say that margin requirement is 25%.
• 12.
  Consumer Credit Regulations: The act of selling a consumer good on a credit basis to the people in general is known as consumer credit rationing.  Such a measure to control credit in the country and regulate money supply is very practical.