Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest. Monetary policy is usually used to attain a set of objectives oriented towards the growth and stability of the economy. These goals usually include stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. Instruments of Monetary Policy:
1. Target Growth in Money Supply: Money supply according to the goals of national economic growth pattern. Should be reviewed in quarterly
To set money supply at a target level BB use the following techniques:
I. Bank Rate: The bank rate is the rate of interest at which BB re-discounts the first class bills of exchange from commercial banks. Whenever BB wants to reduce credit, the bank rate is raised and whenever the volume of bank credit is to be expanded the bank rate is lowered. This is because by change in the bank rate. BB seeks to influence the cost of bank credit.
The efficacy of bank rate policy depends, to a greater extent, on its power to influence the market rates.
There is no organized money market in our country and thereby the market rates seldom respond to bank rate changes. The absence of any kind of conventional relationship between the central bank and other components of the money market further adds to the ineffectiveness of the bank rate policy.
II.Open market operation: BB can influence resources of commercial banks by buying or selling government securities in open market. If BB buys government securities in the market from the commercial banks, this increases the cash base of the commercial banks enabling them to expand credit and conversely If BB sells government securities to the commercial banks, their cash base is reduced. Thus adversely affecting the commercial banks to expand credit.
III. Credit Rationing: under this policy, during the time of stringency, BB rations credit by limiting the amount of credit available to each client and restricting the rediscount facilities to short term bills. It may involve setting limits on the individual banks credit during the specified period.
2. Statutory Reserve Requirement: (a) CRR: Cash Reserve Ratio
(b) SLR: Statutory Liquidity Reserve