16 Questions
Why do commercial banks re-discount commercial papers with the central bank?
To enhance their cash reserves
What is the effect on the money supply when the central bank raises the re-discount rate?
It decreases the money supply
Why do commercial banks raise their discount rate for commercial papers when the central bank raises the re-discount rate?
To decrease the demand for loans
What is the effect of reducing the re-discount rate on the money supply?
It increases the money supply
What is the objective of open market operations when the economy is in recession?
To increase the money supply
What is the effect of the central bank buying government securities and bonds on the market?
It increases liquidity in the market
What is the effect of open market operations on aggregate demand?
It increases aggregate demand
Why do commercial banks increase their lending capacity when the central bank reduces the re-discount rate?
Because they have more excess reserves
What is the primary goal of monetary policy?
To achieve a set of economic objectives
What is the purpose of the required reserve ratio?
To control the amount of credit granted by commercial banks
What happens when the central bank reduces the required reserve ratio?
The money supply increases
What is the rediscount rate?
The interest rate that the central bank receives from rediscount of commercial paper
What is the goal of contractionary monetary policy?
To decrease the money supply
What is the effect of increasing the required reserve ratio on commercial banks?
It decreases their ability to grant credit
What is the purpose of open market operations?
To influence the volume and cost of credit
What is the result of expansionary monetary policy?
An increase in the money supply
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
Learn about the definition and goals of monetary policy, including the tools used by central banks to achieve economic objectives.
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