2. Monetary policy is the 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 monetary policy:
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 Reserve Ratio:
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
The first 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
By this 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 method of 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 time to 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 Margin Requirements:
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.