Quantitative instruments of monetary policy
Business Environment in Nepal
Monetary policy is the process by which the monetary authority of a country, like the central bank or currency board, controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency.
The central bank uses several instruments of monetary policy, referred to as monetary variables at its discretion, to regulate the credit availability and liquidity (money supply) in a manner that controls inflation and at the same time stimulate the growth of the economy.The instruments of monetary policy are also called as “weapons of monetary policy”.Following are the important instruments of monetary policy.
a) Bank Rate policy(BRP):
The Bank Rate Policy (BRP) is a very important technique used in the monetary policy for influencing the volume or the quantity of the credit in a country. The bank rate refers to rate at which the central bank (i.e RBI) rediscounts bills and prepares of commercial banks or provides advance to commercial banks against approved securities. The Bank Rate affects the actual availability and the cost of the credit. Any change in the bank rate necessarily brings out a resultant change in the cost of credit available to commercial banks.
The efficiency of the bank rate as a tool of monetary policy depends on existing banking network, interest elasticity of investment demand, size and strength of the money market, international flow of funds, etc.
b) Open Market Operation(OMO):
Open market operation is the most important instrument of monetary policy. It refers to purchase or sale of government securities, short term as well as long term, at the initiative of central bank, as a deliberate credit policy. These Bonds and securities are purchased or sold from or to the commercial banks and the general public in the country.The OMO is used to wipe out shortage of money in the money market, to influence the term and structure of the interest rate and to stabilize the market for government securities, etc.
c) Change in Reserve Ratio:
The commercial banks are required to keep a limited percentage of their deposits by law with the central bank. The central bank charges the ratio according to the need of controlling the credit.When prices are rising and there is need to control them, the central bank sells securities. The reserves of commercial banks are reduced and they are not in a position to lend more to the business community.
d) Credit Rationing:
This instrument of monetary policy is applied only in time of financial crises. The bank can collect by re-discounting bill of exchange, when credit is rationed by fixing the amount. This method of controlling credit can be justified only as a measure to meet exceptional emergencies, because it is open to serious abuses. There can be a danger, the rationing may not be satisfactory and the central bank may abuse the power by giving preferential treatment to favorite customers.