What is Central Bank ? Quantitative and Qualitative Instruments of Monetary Policy
In this article we are discussing about the credit and money supply control function of the central Bank
After reading this article you will be able to answer the following questions of class 12th macroeconomics unit Money and banking
Q. What is Central Bank?
Q. Controller of money supply and credit in the economy?
Q. What are the various Quantitative and Qualitative Instruments of Monetary Policy control in the economy?
Q. How various instruments of money supply control acts in the situation of excess demand and deficient demand.
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| Central Bank Monetary policy |
CENTRAL BANK :
A central bank is it top most and apex institution in any country which operates, controls, directs, and regulate the monetary and banking structure of the specified country, not only this Central Bank acts as a leader of the money market.
In India the Reserve Bank of India is the central bank of the country .
Central Bank acts as a controller of money supply and credit in the economy it is one of the foremost and important function which Central banks plays in the economy of the country
Let us now discuss the various Quantitative and Qualitative Instruments of Monetary Policy and credit controller function by the central bank or we can say tools of monetary policy in both the situation of excess demand and deficient demand.
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| Instruments of Monetary Policy |
Quantitaive measure of monetary policy
(1) Repo Rate :
Repo rate is the rate at which the central bank of a country lends money to a commercial bank to meet its short-term needs.
• During excess demand
- RBI increases repo rate which increases the cost of borrowing of the commercial bank from the central bank
- it further increases market rate of interest by the commercial bank which discourages berbers from taking loans from the bank
- it reduces the ability of commercial banks to create credit in the economy
Thus , there is DECREASE in money supply due to which purchasing power also Decreases and Thus aggregate demand also decrease.
Therefore by increasing Repo Rate the central bank is able to control the situation of excess demand
• During deficient demand
- RBI decrease repo rate which decreases the cost of borrowing of commercial bank from the central bank
- it further decreases the market rate of interest by the commercial banks
- which encourages Borrowers for taking loans.
- it increases the ability of commercial banks to create credit
Thus, there is increase in money supply due to which purchasing power also increases and consequently aggregate demand also increases.
(2) Bank Rate :
Bank rate is the rate at which Central Bank of a country lend money to the commercial bank to meet its long-term requirements
• During excess demand
- RBI increases the bank rate which increase the cost of borrowing of commercial bank from the central bank
- it further increases the market rate of interest by the commercial banks
- which discourages the borrower from taking loans
- it reduces the ability of commercial banks to create credit.
Thus, there is decrease in money supply due to which purchasing power also decreases
Therefore by increasing the bank rate the central bank is able to control the situation of excess demand.
• During deficient demand.
- RBI decreases the bank rate which decreases the cost of borrowing of commercial bank from Central Bank.
- it will decreases the market rate of interest by the commercial banks.
- this will encourage the borrowers to take loan from the commercial bank
- it will increase the credit creating capacity of the commercial banks.
Thus, there is increase in money supply due to which purchasing power also increases.
Therefore by decreasing the bank rate the central bank is able to control the situation of deficient demand.
(3) Reverse Repo Rate :
Reverse repo rate is the exact opposite of repo rate it is the rate at which RBI borrows money from commercial bank for the short-term need requirement.
• During excess demand
- RBI increases reverse repo rate which encourages commercial bank to put more surplus (Cash reserves) with Central Bank
- so now commercial banks are left with less cash balance
This will reduce their credit creating capacity which further reduces money supply inturn reducing the purchasing power and consequently aggregate demand reduces.
· --During deficit demand
RBI decreases Resverse repo rate which make commercial bank to not put their surplus money with Central bank.So now Commercial bank is left with lot of money .
This increases the purchasing power of public.
(4) Open market operations:
It refers to buying and selling of government securities by the central bank from/ to the public and commercial banks.
• During excess demand
- The central bank sell the security which reduces the reserves of commercial bank
- It adversely affects the banks ability to create credit.
Therefore it decreases the money supply in the economy which will reduce the purchasing power in the economy
Thus, aggregate demand reduces
• During deficient demand
- the central bank purchases the security which increases the Reserve and raises the commercial banks ability to give credit( creating more credit)
Thus, it will increases money supply in the economy ,which increases the purchasing power and Aggregate demand is going to increase.
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| Money |
(5)LRR ( variable reserve ratio method)
I) cash reserve ratio(CRR):
Cash reserve ratio refers to the minimum percentage of the net demand and time liabilities to be kept by the commercial banks with the central bank in a particular period of time.
II) statutory liquidity ratio (SLR) :
It refers to the minimum percentage of net demand and time liabilities with the commercial banks are required to maintain with themselves.
• During excess demand
-The central bank increases the SLR and CRR which further reduces the excess reserves of commercial bank.
- it will reduce the credit creating capacity of the commercial bank which will result in the the decrease in money supply in the economy
Thus, the purchasing power in the economy reduces and the aggregate demand reduces.
• During deficient demand
- the central bank decreases the SLR and CRR which further increases the excess reserves of commercial bank.
- it will increase the credit creating capacity of the commercial banks which will result in the increase in the money supply in the economy.
Thus, the purchasing power in the economy increases and the Aggregate demand increases.
Qualitative Measure of monetary policy
(6) Margin requirements:
Margin refers to the difference between the amount of loan on the market value of security which is offered by the borrower against the loan in the period of their transaction.
• During excess demand
- an increase in margin reduces the borrowing capacity of the borrowers which further reduces money supply in the economy.
Thus, the purchasing power reduces and aggregate demand reduces
• During deficient demand
- An decrease in margin increasing the borrowing capacity of the borrower whitch for the increase in money supply in the economy.
Thus,.it will increase the purchasing power and aggregate demand increases.
7) 7) Moral Suasion :
In this persuasion with pressure is applied by central bank on other banks to make them work according to the manner they want.
· During Excess demand
Central bank make or alter policies in a way to minimize credit giving capacity of commercial banks which in return reduces the purchasing capacity of the public.
· During deficit demand
Central bank make or alter policies in a way to maximize credit giving capacity of commercial banks which in return enhance the purchasing capacity of the public.
8) 8) Selective credit control
In this Central Bank Gives instructions to other banks to give or not to give credit for a particular reason or purpose or to a particular sector .
· During excess demand
In this Situation Central bank make or tighten the selective control measures and commercial banks are only allowed to give loans to fewer sectors or purposes.
This reduces the purchasing power of the public.
· During deficit demand
In this situation Central bank make or loosen the selective control measures and allow commercial banks to give more and more loans.
This increases the purchasing capacity of the public.
Difference Between Quantitative and Qualitative Measures
Qualitative measures vs Quantitative Measures
Quantitative Measures | Qualitative Measures |
Quantitative Measures are general in nature and it affects all the sectors of making use of bank credit. | Qualitative measures are specific in nature. It affects the flow of credit for a particular use. |
Quantitative measures are also known as traditional methods. | Qualitative measures are also known as selective methods of control. |
Quantitative measures include Repo rate , Reverse Repo Rate , Bank Rate , Open Market Operations , etc. | Qualitative Measures Include Moral suasion , Selective Credit Control, etc. |
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