Monetary policy instrument is the process of drafting, announcing, and implementing the plan of actions taken by the central bank, currency board, or other competent monetary authority of a country that controls the quantity of money in an economy and the channels by which new money is supplied.
Definition
Johnson defines monetary policy “as policy employing central bank’s control of the supply of money as an instrument for achieving the objectives of general economic policy.”
G.K. Shaw defines it as “any conscious action undertaken by the monetary authorities to change the quantity, availability or cost of money.”
Instruments of monetary policy
- Bank rate policy- The minimum lending rate is the bank rate of the central bank at which it rediscounts first class bills of exchange and government securities held by the commercial banks. Central banks raise the bank rate when it finds that inflationary pressures have started emerging within the economy. Commercial bank borrows less as borrowing from central bank become costly. In turn, commercial banks raise their lending rate to the business community and the borrowers borrow less from commercial bank. On the other hand central banks lower the bank rate when prices are depressed.
- Open market operation – open market operations refer to sale and purchase of securities in the money market by the central bank. The central bank sells securities, when prices are rising and there is need to control them. On the contrary, the central bank buys securities, when recessionary forces start in the economy.
- Changes in reserves ratio – every bank is required to keep certain percentage of its total deposits with the central bank. The central bank raise the reserve ratio when prices are rising. Banks keep more with the central bank. In the opposite case, the reserves of commercial banks increases, when the reserve ratio decreases.
- Selective credit controls – For particular purposes selective credit controls influence specific types of credit. The central bank raises the margin requirement when there is brisk speculative activity in the economy or in particular sectors in certain commodities and prices start rising. The result is that the borrowers receive less money in loans against specified securities. In case of recession in a particular sector, the central bank encourages borrowing by lowering margin requirements.
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