The question that educareguide is considering is – “Instruments of Monetary Policy used by the Central Bank?”.
We are going to look at this topic into greater details.
It is the work of the central bank to ensure the control of money supply in an economy.
The mechanism of money supply can also be referred to as tools of monetary policy.
Stay tuned and keep reading. Our content is going to answer the banking question of many businessmen and students alike.
This Notes Is Relevant To Students Writing The Following Examination – Instruments Used By The Central Bank
- Waec wassce Business Management
- Waec Wassce – Social Studies
- Cambridge International College (CIC)– Business Administration
- Institute of Commercial Management (ICM)– Business Administration
- And many others.
I must say that this content is a solution to many exams questions. It is not relevant to only business management, however it is also very relevant to economics, government, etc. questions that are asked.
Mechanism Used By The Central Bank To Regulate Money Supply
The Bank Rate- A Tool The Bank of Japan Use To Regulate Money Supply
The bank rate is the pivot of all interest rates because all interest rates depend on it. The interest rate charged by the commercial banks depends on the bank rate:
The bank rate is the minimum rate of interest that the central bank charges on loans and advances granted to commercial banks and for re-discounting bills of exchange.
If the hank rate goes high, all other rates of interest would be high and vice versa. If the central bank wants to reduce money supply, it raises the bank rate so that commercial banks would be discouraged from borrowing, more.
If the bank rate is high, commercial banks will also raise the interest rate on loans they grant to their customers and thus deter them from borrowing. On the other hand if the central bank wants to increase the money supply, the bank rate would be reduced.
Effectiveness of this policy mostly depends on the business atmosphere. If there is lucrative business activities, businessmen will still borrow from the commercial banks irrespective of the rate of interest.
Hence, commercial banks will also go to the central bank to borrow money no matter the level of the bank rate. I must say that if you want to find out how the central bank control money supply, then the use of the bank rate is among the three main tools of monetary policy.
Open Market Operation- A Mechanism The Bank of Canada (BOC) Use To Regulate Money Supply
The most important tool that the central bank has for influencing the supply of money is the purchase and sale of government bonds. Not only that, but other securities in the open- market and this is known as open market operation.
To reduce the money supply, the central bank sells securities to the commercial banks and the public. Customers of the commercial banks who want to buy the securities will draw cheques on the commercial banks thereby reducing the reserves of the commercial banks.
Through this process money moves from the public through the commercial banks to the central bank thereby reducing money in circulation. The central bank buys securities from the commercial banks and the public when it wants to increase money in circulation.
This will increase the cash vault in commercial banks, and thus enables them grant loans and advances to the public and hence increase money supply. The effectiveness of this policy depends largely on the level of monetization, that is existence of the money and capital markets.
If money and capital markets are developed in the economy the policy will be effective and vice versa. This is the most ineffective instrument in the developing countries because the level of monetization and education is low.
The Cash Ratio- An Instrument The Bank of Australia Use To Regulate Money supply
This is the minimum percentage of commercial- banks deposit (cash reserve requirements) which is expected to be kept with the central bank. The tool is among the four major instruments of monetary policy of the central bank.
To reduce the supply of money the central bank raises the cash ratio, so. that the commercial banks are legally obliged to deposit a huge Percentage of their cash with the central bank.
This will reduce the cash in the vault of commercial banks and thereby making them unable to grant more credit to the public.
The reverse is true if the central bank wishes to increase money supply. The effectiveness of this policy depends on whether the commercial banks have enough short-term securities or not.
If they have, it implies that they can easily sell them to the central bank to get some cash and make the policy ineffective.
Besides, due to the dominance of expatriate banks, the policy may not be effective in the least developed countries.
Special Deposit- A Method The Bank of New York Use To Regulate Money Supply
Quite apart from the constant deposits, the commercial banks are legally obliged to keep with the central bank a special percentage of their deposit.
When special _deposits are kept with the central bank, the amount of money left with commercial banks is reduced and as a result their ability to give loans also reduces.
This weapon is very effective because the central bank can call for a huge amount of the commercial banks’ deposits as special deposits.
Thus, it reduces tremendously the cash in their vault and hence checking their ability to give more loans. However the problem posed by the foreign banks may hinder the effective operation of this policy.
Directive Tool The Bank of England Use To Regulate Money Supply
Directives is an instruments of monetary policy used by central bank. They are in the form of instructions given by the central bank to the commercial banks regarding the direction of their loans and advances.
It tells the commercial banks where their loans should go and the percentage they should grant.
For example, the central bank may direct that so much should be given to the Agricultural and Industrial sectors but nothing to private businessmen.
The effectiveness of this policy depends on government’s interference and availability of collateral securities. This policy has been ineffective due to lack of supervision which enables the commercial banks flout the directives.
Moral Suasion – A Means The Bank Of Ghana Use To Regulate Money Supply
This is an appeal by the central bank to the various commercial banks to reduce or increase money supply through credit creation.
This policy may not be effective unless it is backed by law as an instrument of monetary control. Besides, most of the banks are.profit oriented organizations.
Conclusion: Instruments Used By The Central bank
I must conclude by saying that this topic must be taken very serious. Apart from business students who need this for academic purposes, businessmen and businesswomen must also be aware of some of these facts.
This will help businesses to deal with bank very effectively.
Every economy needs some tools used by Central Banks to control money supply. These monetary policy instruments helps to stabilize the currency of the country.
It also helps to ensure economic growth and sustained development. Check out more content that educareguide offers.
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