Thursday, 13 February 2014

Monetary Policy of the Central Bank of a Country

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The primary function of a Central Bank of a country is to formulate Monetary Policies for a country. The Central Bank also has the responsibility of administering the monetary policy. Monetary policies are made to affect and regulate the level of aggregate demand of a country. The objectives of Monetary Policies are to regulate the growth of the country and to achieve stability of price levels. For this purpose, the Central Bank uses certain instruments.
Money supply will have its effects on output and prices. A situation of excess money supply would imply that there is more money in the economy without simultaneous production of goods and services. This will lead to an inflationary situation. A deficit of money supply will mean that the demand for goods and services will reduce. This will in turn curtail the production of goods and services.
The main instrument of monetary policy of the Central Bank is the control and regulation of money supply within the economy. The traditional measures of the Central Bank are Quantitative Credit Control Measures. The instruments include open market operations (sale and purchase of Government Bonds, treasury bills, securities and so on), changes in Bank Rate (discount rate at which the Central Bank discounts the Commercial Bank’s bill of exchange) and changes in statutory reserve ratios (proportion of a Commercial banks time and demand deposits which they are required to deposit in the Central Bank). All these measures directly and indirectly influence the credit creation capacity of commercial banks. In this manner, the Central Bank of a country seeks to influence the level of money stock within an economy.
The Central Bank can also use selective credit control measures to regulate the flow of funds within an economy. These methods of moral persuasion are meant to control the flow of credit to particular sectors only, while at the same time maintaining the total amount of credit available within an economy. Selective control measures are meant to change the composition of credit from an undesirable to a desirable pattern. Typical examples of selective control measures include loans at lower rates available to defense sector to build the defense capacity of a country and the entrepreneurs to build the rural infrastructure.

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