Management Notes

Reference Notes for Management

Bank rate policy is not very effective because-

Bank rate policy is not very effective because-

    1. It requires a well-developed money market
    2. It cannot operate effectively
    3. All banks are not under the control of central bank
    4. All the above

Correct Answer: It requires a well-developed money market

 Answer Explanation

The correct answer is “Bank rate policy is not very effective since it requires a well-developed money market”. Bank rate policy is a key tool of monetary control. It relies on a well-functioning money market to accomplish its objectives.

In a well-developed money market, central bank policy rate changes are efficiently transmitted throughout the financial system, influencing financial institutions’ borrowing and lending behavior.

Central banks use bank rate policy as a monetary policy tool to influence interest rates and, in turn, control economic activity. The central bank sets a benchmark interest rate, or policy rate. In the economy, this rate is referred to as the reference rate. In the broader financial market, interest rates rise when the central bank raises the bank rate, making it more expensive for commercial banks to borrow from it. As a result, borrowing costs rise for consumers and businesses, leading to reduced borrowing and spending, and vice versa when the central bank lowers its interest rate.

Why the other options are not correct

b. It cannot operate effectively:

This option is incorrect. When implemented in an appropriate economic environment, bank rate policy can indeed operate effectively. Central banks use bank rate policy to influence interest rates in the economy.

The central bank affects the cost of borrowing for commercial banks, thereby affecting consumers’ and businesses’ borrowing rates. Investment, consumption, and overall economic activity are impacted by changes in interest rates.

Inflationary pressures and short-term interest rates can be greatly influenced by bank rate policy. By adjusting the bank rate, the central bank can manage liquidity in the banking system, affecting market interest rates. As a result, businesses and consumers borrow and spend in different ways, influencing economic growth and inflation.

c. All banks are not under the control of central bank

While it is true that not all banks are directly under the control of the central bank, this does not undermine the effectiveness of bank rate policy. (c) All banks are not under the central bank’s control:

This option is incorrect. The central bank’s decisions regarding the bank rate have a wide range of implications for the entire banking system. Even if some banks are not directly regulated. The bank rate influences the cost of funds for banks as well as their lending and deposit rates, thereby affecting credit creation and economic activity.

As a result of open market operations, reserve requirements, and other policy tools, central banks have a significant influence on the entire banking system. The central bank can still influence the overall credit conditions and economic activity through its bank rate policy, despite not having direct control over all banks.

d. All of  the above

Option A is the correct answer so, this option becomes incorrect.

Conclusion

A well-developed money market is crucial to the effectiveness of bank rate policy as a tool for monetary control. A robust money market ensures the efficient transmission of the central bank’s policy rate changes, allowing the central bank’s policy rate policy to effectively influence borrowing and lending behavior in the economy.

Bank rate policy has limitations and may not be the only tool for monetary control, but it remains an important instrument for central banks to achieve their monetary policy goals.

In practice, central banks often use a combination of tools, including bank rate policy, open market operations, reserve requirements, and forward guidance, to address varying economic conditions and achieve desired macroeconomic outcomes. To achieve stability and sustainable economic growth, central banks must carefully calibrate their monetary policy response based on the prevailing economic circumstances.

Which of the following is not an instrument of selective credit control?

Bibisha Shiwakoti

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