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?

    <p>It increases the money supply</p> Signup and view all the answers

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

    <p>To increase the money supply</p> Signup and view all the answers

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

    <p>It increases liquidity in the market</p> Signup and view all the answers

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

    <p>It increases aggregate demand</p> Signup and view all the answers

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

    <p>Because they have more excess reserves</p> Signup and view all the answers

    What is the primary goal of monetary policy?

    <p>To achieve a set of economic objectives</p> Signup and view all the answers

    What is the purpose of the required reserve ratio?

    <p>To control the amount of credit granted by commercial banks</p> Signup and view all the answers

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

    <p>The money supply increases</p> Signup and view all the answers

    What is the rediscount rate?

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

    What is the goal of contractionary monetary policy?

    <p>To decrease the money supply</p> Signup and view all the answers

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

    <p>It decreases their ability to grant credit</p> Signup and view all the answers

    What is the purpose of open market operations?

    <p>To influence the volume and cost of credit</p> Signup and view all the answers

    What is the result of expansionary monetary policy?

    <p>An increase in the money supply</p> 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.

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