Explain the various tools of monetary policy
- Open market operation, this is the sale and purchase of government securities, bonds and treasury bills with the aim of regulating money in circulation. When the central bank buys securities, it adds cash to the banks’ reserves. That gives them more money to lend. When the central bank sells the securities, it places them on the banks’ balance sheets and reduces its cash holdings. The bank now has less to lend.
- Legal reserve requirements/Cash Reserve Ratio (CRR): This is the proportion of the bank’s total deposits that commercial banks are required by law to keep in the central bank. Low reserve requirement allows banks to lend more of their deposits and thus increase money in circulation. It’s expansionary because it creates credit.
- Special deposits, the central bank can require commercial banks to have supplementary reserves over and above the legal reserve requirements. This limits the amount of money in circulation. If the central bank wishes to restrict the amount of money available for lending to the public, it increases supplementary reserves but if it wishes to increase money in circulation, it reduces the supplementary reserve.
- The bank rate/discount rate, this the rate at which the central bank lends to commercial banks. When the bank rate is high, commercial banks will not borrow much from the central bank and this reduces the amount of money available to commercial banks for lending and vice versa.
- Marginal requirements, this refers to the difference between the value of the collateral security and the amount of money advanced as security and the money advanced as a loan. If commercial banks increase marginal requirements, little money is lent to the public hence little money in circulation and vice versa.
- Statutory Liquidity Ratio (SLR)/Reserve ratio; this is the proportional of a bank’s total deposits that must be kept in liquid/cash form to cater for the cash demands of customers. If the cash ratio is raised, then there is little money left for lending out and this reduces the amount of money in the circulation and vice versa.
- Credit Ceiling/Selective credit control; here, the central bank issues directive to commercial banks to extend credit up to a certain amount to priority sectors as outlined in the development programs of economy. This also reduces the amount of money in circulation since it encourages certain activities at the expense of others.
- Moral suasion; this relies on the power of the central bank to persuade commercial banks either to restrict or extend money credit to the public.
CATEGORIES Economics
TAGS Dr. Bbosa Science
