Monetary Policy and its Objectives

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Questions and Answers

Why do commercial banks re-discount commercial papers with the central bank?

To reduce the volume of funds allocated for lending

To enhance their cash reserves (correct)

To reduce their cash reserves

To increase the money supply

What is the effect on the money supply when the central bank raises the re-discount rate?

It increases the money supply

It decreases the money supply (correct)

It leads to economic recession

It has no effect on the money supply

Why do commercial banks raise their discount rate for commercial papers when the central bank raises the re-discount rate?

To increase the volume of funds allocated for lending

To increase the interest rate on loans

To decrease the demand for loans (correct)

To reduce the money supply

What is the effect of reducing the re-discount rate on the money supply?

It increases the money supply Signup and view all the answers

What is the objective of open market operations when the economy is in recession?

To increase the money supply Signup and view all the answers

What is the effect of the central bank buying government securities and bonds on the market?

It increases liquidity in the market Signup and view all the answers

What is the effect of open market operations on aggregate demand?

It increases aggregate demand Signup and view all the answers

Why do commercial banks increase their lending capacity when the central bank reduces the re-discount rate?

Because they have more excess reserves Signup and view all the answers

What is the primary goal of monetary policy?

To achieve a set of economic objectives Signup and view all the answers

What is the purpose of the required reserve ratio?

To control the amount of credit granted by commercial banks Signup and view all the answers

What happens when the central bank reduces the required reserve ratio?

The money supply increases Signup and view all the answers

What is the rediscount rate?

The interest rate that the central bank receives from rediscount of commercial paper Signup and view all the answers

What is the goal of contractionary monetary policy?

To decrease the money supply Signup and view all the answers

What is the effect of increasing the required reserve ratio on commercial banks?

It decreases their ability to grant credit Signup and view all the answers

What is the purpose of open market operations?

To influence the volume and cost of credit Signup and view all the answers

What is the result of expansionary monetary policy?

An increase in the money supply Signup and view all the answers

Study Notes

Monetary Policy

Monetary policy is a set of actions taken by the central bank to adjust the money supply in proportion to the desired level of economic activity to achieve economic objectives.

Goals of Monetary Policy

Achieve price stability
Achieve full employment
Achieve high growth rates
Maintain stability of financial markets
Stabilize the interest rate
Achieve exchange rate stability

Tools of Monetary Policy

Quantitative Tools

Required Reserve Ratio
Rediscount Rate
Open Market Operations

Required Reserve Ratio

Determined according to prevailing economic conditions
Objective is to control the amount of credit granted by commercial banks and thus control the money supply
In times of recession, reduce required reserve ratio to increase excess reserves and credit availability
In times of inflation, increase required reserve ratio to decrease money supply and purchasing power

Rediscount Rate

Interest rate received by the central bank from rediscount of commercial paper or borrowing from the central bank
Commercial banks re-discount commercial papers or borrow from the central bank to enhance cash reserves
In times of inflation, increase rediscount rate to discourage commercial banks from re-discounting and reduce funds for lending
In times of recession, reduce rediscount rate to encourage commercial banks to re-discount and increase lending

Open Market Operations

Central bank sells or buys securities, especially government securities, to influence the money supply
In times of recession, buy government securities to increase liquidity and purchasing power
In times of inflation, sell government securities to decrease liquidity and reduce money supply

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Description

Learn about the definition and goals of monetary policy, including the tools used by central banks to achieve economic objectives.