Monetary policy refers to how central banks use tools like interest rates, money supply, and credit conditions to achieve goals like price stability, economic growth, and unemployment control. The main tools are quantitative and qualitative credit controls. Quantitative controls directly target money supply through interest rates, open market operations, and reserve requirements. Qualitative controls influence credit allocation through margin requirements, credit rationing, and differential interest rates. Monetary policy can be expansionary by increasing money supply to boost economic activity, or contractionary by decreasing money supply to curb inflation.
2. Monetary policy
Monetary policy is the process by which the
monetary authority of a country, like the central
bank or currency board, controls the supply of
money, often targeting an inflation
rate or interest rate to ensure price stability and
general trust in the currency
Further goals of a monetary policy are usually to
contribute to economic growth and stability, to
lower unemployment, and to maintain
predictable exchange rates with other
currencies.
3. Monetary policy
Monetary policy is referred to as either being
expansionary or contractionary. Expansionary
policy is when a monetary authority uses its
tools to stimulate the economy.
An expansionary policy increases the total
supply of money in the economy more rapidly
than usual. It is traditionally used to try to
combat unemployment in a recession by
lowering interest rates in the hope that easy
credit will entice businesses into expanding
4. Monetary policy
The opposite of expansionary monetary
policy is contractionary monetary
policy, which slows the rate of growth in
the money supply or even shrinks it.
This slows economic growth to
prevent inflation
5. Instruments of monetary policy
(credit control)
Quantitative credit control
Control and adjust total quantity or
the volume of deposits created by the
commercial banks
Qualitative credit control
These instruments direct or restrict the
flow of credit in specific area of economic
activity.
6. Quantitative credit control
Lending rates
Bank rate- long term loan interest rate without mortgage
to commercial bank.
Repo rate- short term loan interest rate with mortgage to
commercial bank.
Reverse repo rate- Reverse repo rate is the rate at
which the central bank of a country borrows money
from commercial banks within the country.
Open market operations
Deliberate purchase and sale of government securities in
the money market by the central bank, with the
objective of expansion or contraction of credit and
general economic activity
7. Quantitative credit control
Reserve requirements
In view of safety and liquidity, the commercial
banks are legally required to keep a part of their
total demand and time deposit as reserve. By
raising the reserve ratio to be maintained by every
bank, the central bank can reduce the volume of
credit
Cash reserve ratio: Minimum cash reserve which
the banks are required to keep with the central
bank
Statutory liquidity ratio: Minimum amount of
liquidity, which the banks are required to keep with
them
8. Qualitative credit control
Margin requirement
The central bank can order the commercial banks to
lend an amount lower than the volume of a security.
A higher margin used during inflationary situation will
reduce the amount of loan given by the banks.
Rationing of credit
Credit rationing is a method of controlling and
regulating the purpose for which the banks grant
credit
Regulation of consumer credit
The central bank can regulate the terms and
conditions under which consumer credit is to be given
by the banks
9. Qualitative credit control
Differential rate of interest
Under this scheme the central bank fixes up different
rates on interest to be charged by the banks from
different borrowers who borrow for different purposes
Moral suasion
It implies persuasion and request made by the central
bank to commercial banks to follow the general policy of
central bank
Direct action
Direct action refers to all the controls and directions,
which the central bank may enforce on all banks or any
bank in particular concerning lending and investment