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Instruments of Monetary Policy

This document discusses the instruments of monetary policy used by central banks. It outlines six main quantitative instruments: [1] cash reserve ratio, [2] statutory liquidity ratio, [3] bank rate, [4] repo rate, [5] reverse repo rate, and [6] open market operations. It also discusses two qualitative instruments: [1] changing margin money and [2] direct action and moral suasion. The document then provides details on how several of the quantitative instruments work, including bank rate policy, open market operations, and changes in reserve ratios. It concludes with an overview of selective credit controls as another monetary policy tool.

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Muhammad Madni
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106 views

Instruments of Monetary Policy

This document discusses the instruments of monetary policy used by central banks. It outlines six main quantitative instruments: [1] cash reserve ratio, [2] statutory liquidity ratio, [3] bank rate, [4] repo rate, [5] reverse repo rate, and [6] open market operations. It also discusses two qualitative instruments: [1] changing margin money and [2] direct action and moral suasion. The document then provides details on how several of the quantitative instruments work, including bank rate policy, open market operations, and changes in reserve ratios. It concludes with an overview of selective credit controls as another monetary policy tool.

Uploaded by

Muhammad Madni
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Money Banking and Finance

Assignment

Submitted By: Submitted To:


Muhammad Madni Miss.Uzma Bashir
Roll no: 01 IBF 3 (SIEBF)

Minhaj University Lahore


Money Banking and Finance
Assignment
Instruments Of Monetary Policy

Defination
Monetary policy instruments are the various tools that a central bank can use to
influence money market and credit conditions and pursue its monetary policy
objectives.

Main instruments of the monetary policy are: Cash Reserve Ratio, Statutory
Liquidity Ratio, Bank Rate, Repo Rate, Reverse Repo Rate, and Open Market
Operations.

Instruments of Monetary Policy


The instruments of monetary policy are of two types:
1. Quantitative, general or indirect (CRR, SLR, Open Market Operations, Bank
Rate, Repo Rate, Reverse Repo Rate)
2. Qualitative, selective or direct (change in the margin money, direct action,
moral suasion)
These both methods affect the level of aggregate demand through the supply of
money, cost of money and availability of credit. Of the two types of instruments,
the first category includes bank rate variations, open market operations and
changing reserve requirements (cash reserve ratio, statutory reserve ratio).

Policy instruments are meant to regulate the overall level of credit in the economy
through commercial banks. The selective credit controls aim at controlling specific
types of credit. They include changing margin requirements and regulation of
consumer credit.

We discuss them as under:

a. Bank Rate Policy:


The bank rate is the minimum lending rate of the central bank at which it
rediscounts first class bills of exchange and government securities held by the
commercial banks. When the central bank finds that inflation has been increasing
Money Banking and Finance
Assignment
continuously, it raises the bank rate so borrowing from the central bank becomes
costly and commercial banks borrow less money from it (SBP).

The commercial banks, in reaction, raise their lending rates to the business
community and borrowers who further borrow less from the commercial banks.
There is contraction of credit and prices are checked from rising further. On the
contrary, when prices are depressed, the central bank lowers the bank rate.

It is cheap to borrow from the central bank on the part of commercial banks. The
latter also lower their lending rates. Businessmen are encouraged to borrow more.
Investment is encouraged and followed by rise in Output, employment, income and
demand and the downward movement of prices is checked.

b. Open Market Operations:


Open market operations refer to sale and purchase of securities in the money
market by the central bank of the country. When prices start rising and there is
need to control them, the central bank sells securities. The reserves of commercial
banks are reduced and they are not in a position to lend more to the business
community or general public.

Further investment is discouraged and the rise in prices is checked. Contrariwise,


when recessionary forces start in the economy, the central bank buys securities.
The reserves of commercial banks are raised so they lend more to business
community and general public. It further raises Investment, output, employment,
income and demand in the economy hence the fall in price is checked.

c. Changes in Reserve Ratios:


Under this method, CRR and SLR are two main deposit ratios, which reduce or
increases the idle cash balance of the commercial banks. Every bank is required by
law to keep a certain percentage of its total deposits in the form of a reserve fund in
its vaults and also a certain percentage with the central bank.
When prices are rising, the central bank raises the reserve ratio. Banks are required
to keep more with the central bank. Their reserves are reduced and they lend less.
The volume of investment, output and employment are adversely affected. In the
opposite case, when the reserve ratio is lowered, the reserves of commercial banks
are raised. They lend more and the economic activity is favourably affected.
Money Banking and Finance
Assignment
2. Selective Credit Controls:
Selective credit controls are used to influence specific types of credit for particular
purposes. They usually take the form of changing margin requirements to control
speculative activities within the economy. When there is brisk speculative activity
in the economy or in particular sectors in certain commodities and prices start
rising, the central bank raises the margin requirement on them.

a. Change in Margin Money:


The result is that the borrowers are given less money in loans against specified
securities. For instance, raising the margin requirement to 70% means that the
pledger of securities of the value of Rs 10,000 will be given 30% of their value, i.e.
Rs 3,000 as loan. In case of recession in a particular sector, the central bank
encourages borrowing by lowering margin requirements.

b. Moral Suasion: Under this method SBP urges to commercial banks to help in
controlling the supply of money in the economy.

The
End

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