Tools of monetary policy Flashcards
What do these tools do
These tools provide central banks with a range of options to influence the money supply and, consequently, the overall economic activity in an economy.
Repo rate
Rate at which the central bank is prepared to provide overnight financing to commercial banks
-unable to meet liquidity requirement
discount rate
similar to the repo rate, as the discount rate is increased, the rate of interest charged by the commercial bank increases
Open market operations
-principle tool for MP
it involves the buying and selling of govt securities in the open capital market. If the C.B purchases securities from the public, then this increases the amount of money in circulation which eventually finds itself in the commercial banking system. This leads to a multiple expansion of deposits in the money supply. the rate of interest, consequently, decreases and aggregate expenditure expands.
Issue of notes and coins
The central bank is also able to increase the money supply by simply minting more coins and printing more bank notes and releasing them into circulation
Moral suasion
By simply communicating its wishes to the financial sector. If the central bank wanted to effect a m.c the monetary authorities may request without any compulsory consequences that commercial banks increase liquidity ratio or reduce the amt of loans issued. These actions will result in a decrease in money supply and a reduction in level of aggregate expenditure
Reserve Requirements
Expansionary: By lowering the reserve requirement, the central bank allows commercial banks to hold less money in reserves against their deposits. This increases the amount of money available for lending, which stimulates spending and investment, thereby expanding the money supply.
Contractionary: Raising the reserve requirement compels banks to keep a larger portion of their deposits as reserves. This reduces the amount of money available for lending, leading to a decrease in spending and investment, thereby contracting the money supply.
Open Market Operations:
Expansionary: When the central bank buys government securities from the open market, it injects money into the banking system. Banks have more funds to lend, stimulating economic activity and increasing the money supply.
Contractionary: Selling government securities to the open market removes money from the banking system. This reduces the amount of funds available for lending, which decreases economic activity and contracts the money supply.
Discount Rate:
Expansionary: Lowering the discount rate encourages banks to borrow more from the central bank. This provides them with additional funds to lend, thereby increasing the money supply.
Contractionary: Raising the discount rate makes borrowing from the central bank more expensive, leading to reduced borrowing by commercial banks. This reduces the funds available for lending, contracting the money supply.
Moral Suasion:
Expansionary: Through persuasive communication, the central bank can encourage banks to increase lending and investment, which expands the money supply.
Contractionary: The central bank can use moral suasion to persuade banks to be more cautious with lending and investments, leading to a contraction of the money supply.
