The state has a wide range of monetary policy instruments at its disposal. It is aimed at changing the amount of money in circulation to ensure price stability, normalize the situation on the labor market and increase production.
Instructions
Step 1
Monetary policy objectives can be achieved through the use of general and selective instruments. In the first case, the impact on the general market of loan capital is carried out. Selective instruments regulate specific economic sectors or large market participants. The key common tools are accounting policies, open market transactions and backups. Among the selective ones, one can single out control over certain types of loans, regulation of risks and liquidity, as well as various recommendations.
Step 2
Lending at a discount rate is associated with one of the functions of the Central Bank. It implies the allocation of loans to commercial banks at the discount rate (when issuing loans in the form of bills), or at the refinancing rate (in other forms of lending). They are usually at a level lower than the rates in the short-term capital market. When refinancing rates or discount rates rise, commercial banks reduce borrowing. This leads to a reduction in the volume of lending to individuals or legal entities, as well as to an increase in interest rates on loans. This instrument is also called the expensive money policy. The result is a reduction in the volume of the money supply. The opposite effect has a policy of cheap money, which is achieved by reducing key rates.
Step 3
Changes in the volume of money supply in circulation by the Central Bank can also be achieved by conducting operations on the open market. It is this tool that is key in developed countries. When conducting operations on the open market, the Central Bank buys and sells government securities (reserve assets). Selling leads to a reduction in excess reserves of commercial banks, as well as a decrease in lending opportunities. As a result, the money supply decreases and the borrowing price rises. When buying securities, on the contrary, the money supply grows and the interest rate on loans falls.
Step 4
Monetary policy is also carried out by changing the volume of assets that commercial banks are required to keep in the reserves of the Central Bank. All banks keep only a small part of assets in cash, the rest of the funds are inverted into illiquid assets (for example, loans). When the Central Bank changes the rate of liquidity (it is usually set as a percentage of the volume of deposits), this affects the ability of banks to increase the money supply. The Central Bank uses this tool relatively infrequently.
Step 5
Selective instruments can be used by the Central Bank to exercise control over certain types of credit. For example, by indicating the need to increase making special deposits with the growth of lending. Also, the Central Bank exercises control over the risks and liquidity of banks. In the stock market, regulation is carried out by establishing legal margins. This is done in order not to cause serious damage to the economy with excessive speculation. Finally, the Central Bank can give advice to banks in terms of their policies. For example, to prevent excessive growth of the unsecured loan portfolio.
