Monetary Policy

Study Notes

Monetary Policy

Definition

Monetary policy refers to the actions of a central bank to control the money supply and interest rates to promote economic growth, stability, and low inflation.

Tools

The central bank uses three main tools to implement monetary policy:

Open Market Operations (OMO): buying or selling government securities to increase or decrease the money supply and influence interest rates.
** Reserve Requirements**: setting the minimum amount of reserves commercial banks must hold against deposits, affecting the amount of credit available in the economy.
Discount Rate: setting the interest rate at which commercial banks borrow from the central bank, influencing the prime lending rate and overall interest rates.

Objectives

The primary objectives of monetary policy are:

Price Stability: controlling inflation to maintain a stable general price level.
Economic Growth: promoting sustainable economic growth and job creation.
Financial Stability: maintaining stability in the financial system and preventing crises.

Types

There are two types of monetary policy:

Expansionary Monetary Policy: increasing the money supply and reducing interest rates to stimulate economic growth.
Contractionary Monetary Policy: reducing the money supply and increasing interest rates to combat inflation and slow down economic growth.

Commercial Banking

Definition

Commercial banking refers to the provision of basic banking services to individuals and businesses, including accepting deposits, making loans, and providing payment services.

Functions

The primary functions of commercial banks are:

Accepting Deposits: receiving and holding deposits from customers, providing a safe and secure place to store funds.
Making Loans: providing credit to customers, facilitating borrowing and spending.
Providing Payment Services: facilitating transactions, such as checks, debit cards, and online banking.

Types of Accounts

Commercial banks offer various types of accounts, including:

Checking Accounts: transactional accounts for everyday use, allowing deposits, withdrawals, and payments.
Savings Accounts: time deposits with interest, encouraging customers to save.
Certificates of Deposit (CDs): time deposits with a fixed interest rate and maturity date.

Banking Operations

Commercial banks engage in various operations to generate revenue, including:

Lending: making loans to customers, earning interest income.
Investing: investing in securities, such as government bonds and stocks, earning returns.
Fee-based Services: offering services like overdraft protection, ATM usage, and account maintenance fees.

Monetary Policy

Monetary policy involves central bank actions to regulate money supply and interest rates.
Aims to foster economic growth, stability, and low inflation rates.

Tools of Monetary Policy

Open Market Operations (OMO):
- Involves the buying/selling of government securities.
- Affects money supply and influences interest rates.
Reserve Requirements:
- Specifies minimum reserves banks must hold against deposits.
- Impacts the credit availability in the economy.
Discount Rate:
- Determines interest rates at which banks borrow from the central bank.
- Influences prime lending rates and overall interest rates.

Objectives of Monetary Policy

Price Stability:
- Focuses on controlling inflation to ensure stable prices.
Economic Growth:
- Seeks to promote sustainable growth and job creation.
Financial Stability:
- Aims to maintain stability in the financial system and avert crises.

Types of Monetary Policy

Expansionary Monetary Policy:
- Increases money supply and lowers interest rates to spur economic growth.
Contractionary Monetary Policy:
- Decreases money supply and raises interest rates to combat inflation and slow growth.

Commercial Banking

Commercial banking provides essential financial services to individuals and businesses.
Services include accepting deposits, making loans, and facilitating payment transactions.

Functions of Commercial Banks

Accepting Deposits:
- Provides secure storage for customer funds.
Making Loans:
- Offers credit to facilitate borrowing and spending.
Providing Payment Services:
- Aids in transactions through checks, debit cards, and online banking.

Types of Accounts Offered

Checking Accounts:
- Allow daily transaction activities such as deposits and withdrawals.
Savings Accounts:
- Offer interest on time deposits, encouraging savings behavior.
Certificates of Deposit (CDs):
- Feature fixed interest rates and set maturity dates for time deposits.

Banking Operations

Lending:
- Loans provide interest income for banks, a primary revenue source.
Investing:
- Investing in securities like government bonds and stocks generates returns.
Fee-based Services:
- Banks earn additional revenue through services like overdraft protection and ATM fees.