Saturday, August 22, 2009
Instruments and Techniques of Monetary Policy
Monetary policy mainly aims at controlling the volume of credit in the country and sometimes also the direction of its use. It is not possible to describe in detail the methods by which this is done, for which reference may be made to any good book on the theory of money and banking. A brief mention of them, however must be made for completeness of our discussion.
Monetary policy may achieve credit control in various ways depending upon whether the control desired is “quantitative control” or “qualitative control”. The former refers to the volume of purchasing power and latter to the use to which it may be put.
(a) QUANTITATIVE CONTROL
The methods of quantitative control include the following.
(i) Bank Rate Policy: The Central Bank of the country raises or lowers as needed, its Bank Rate (discount rate) for first calls paper thus influencing other interest rate sin the money market. A higher rate discouraged and lower rate encourages bank loans ad hence credit expansion. Thus is regulates and controls the volume of purchasing power in the economy for carrying on economic activities.
(ii) Open Market Operations: The Central Bank buys or sells, as the need may be, Government securities in the open market. By purchasing the securities it adds to the balances of commercial banks with itself and by selling them it reduces such balances. Balances with the Central Bank being as good as cash, such operations expand and restrict respectively the power of commercial banks to create credit when they sell of buy such securities.
(iii) Variable Reserve Ratios: The Central Bank requires a certain percentage of the liabilities of commercial banks (or member banks) to be kept in form of reserves with it under the law. This ratio can be increased when credit contraction is desired and decreased when the object is to expand credit.
(iv) Credit Rationing: The Central Bank may put limits on the issue of credit (overall or for particular purposes) on the part of the member banks. These limits may be increased or decreased as needed by the monetary situation in the country.
(b) QUALITATIVE CONTROL
It includes following.
(i) Moral Suasion: Central Bank through direct advice or persuasion may influence the banks to follow particular lines of policy considered necessary to meet a particular situation.
(ii) Consumer Credit Regulation: In times of inflationary pressure the Central Bank may put restrictions on loans to consumers. If consumption needs encouragement the Central Bank may allow commercial banks to advance loans for consumption.
(iii) Publicity: This method is used usually accelerating the pace of economic development. This implies issuing of weekly statistics, periodical reviews about money market conditions, public finance, trade, industry, weekly balance sheet etc for the information of commercial banks, this convincing them of the desirability of following particular lines of policy.
(iv) Variable Margin Requirements: Margin requirements may be increased if the object is to discourage, and decreased if the aim is to encourage credit only for speculative activities in the stock exchange.
(v) Direct Action: This method is used by Central Bank usually to rediscount bills of banks following policies which are inconsistent with the Central Banking policy. This method is rarely used and only as last resort.
To be fully effective in achieving their aims these methods pre-suppose a well-developed money market which is sensitive to the actions taken by the Central Bank. If there is a large non-monelised sector and net of banking institutions is not wide enough to cover the country, or there is absence of organised banks prepared to cooperate in the national interest monetary policy will face difficulties in achieving its objectives.
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