Discuss the main instruments of monetary policy.

Instruments and Techniques of Monetary Policy

Monetary policy mainly aims at controlling the volume of credit in the country and sometimes
also the direction of its use. It is not possible to describe in detail the methods by which this is
done, for which reference may be made to any good book on the theory of money and banking. A
brief mention of them, however must be made for completeness of our discussion.
Monetary policy may achieve credit control in various ways depending upon whether the control
desired is quantitative control or qualitative control. The former refers to the volume of
purchasing power and latter to the use to which it may be put.
(a) QUANTITATIVE CONTROL
The methods of quantitative control include the following.
(i) Bank Rate Policy: The Central Bank of the country raises or lowers as needed, its Bank Rate
(discount rate) for first calls paper thus influencing other interest rates in the money market. A
higher rate discouraged and lower rate encourages bank loans ad hence credit expansion. Thus is
regulates and controls the volume of purchasing power in the economy for carrying on economic
activities.
(ii) Open Market Operations: The Central Bank buys or sells, as the need may be, Government
securities in the open market. By purchasing the securities it adds to the balances of commercial
banks with itself and by selling them it reduces such balances. Balances with the Central Bank
being as good as cash, such operations expand and restrict respectively the power of commercial
banks to create credit when they sell of buy such securities.
(iii) Variable Reserve Ratios: The Central Bank requires a certain percentage of the liabilities of
commercial banks (or member banks) to be kept in form of reserves with it under the law. This
ratio can be increased when credit contraction is desired and decreased when the object is to
expand credit.
(iv) Credit Rationing: The Central Bank may put limits on the issue of credit (overall or for
particular purposes) on the part of the member banks. These limits may be increased or
decreased as needed by the monetary situation in the country.
(b) QUALITATIVE CONTROL
It includes following.
(i) Moral Suasion: Central Bank through direct advice or persuasion may influence the banks to
follow particular lines of policy considered necessary to meet a particular situation.
(ii) Consumer Credit Regulation: In times of inflationary pressure the Central Bank may put
restrictions on loans to consumers. If consumption needs encouragement the Central Bank may
allow commercial banks to advance loans for consumption.

(iii) Publicity: This method is used usually accelerating the pace of economic development. This
implies issuing of weekly statistics, periodical reviews about money market conditions, public
finance, trade, industry, weekly balance sheet etc for the information of commercial banks, this
convincing them of the desirability of following particular lines of policy.
(iv) Variable Margin Requirements: Margin requirements may be increased if the object is to
discourage, and decreased if the aim is to encourage credit only for speculative activities in the
stock exchange.
(v) Direct Action: This method is used by Central Bank usually to rediscount bills of banks
following policies which are inconsistent with the Central Banking policy. This method is rarely
used and only as last resort.
To be fully effective in achieving their aims these methods pre-suppose a well-developed money
market which is sensitive to the actions taken by the Central Bank. If there is a large nonmonetized sector and net of banking institutions is not wide enough to cover the country, or there
is absence of organized banks prepared to cooperate in the national interest monetary policy will
face difficulties in achieving its objectives.
Balance of payment refers to the difference between the total payments out of a country
during a given period of time. These payments are of visible and invisible items.

DIFFERENCE BETWEEN BOT & BOP

1- Definition
Balance of Trade (BOT)

Balance of Payment (BOP)

BOP is the difference between the values

BOT is the difference between the values of exports and imports of both visible and
of exports and imports of only physical invisible items (goods and services) of a
items (goods) of a country during a given country during a given period of time
period of time (usually one year).

(usually one year).

2- Surplus or Deficit

Balance of Trade

Balance of Payment

If the value of visible exports is greater

than value of visible imports, the balance If the value of the total receipts is greater
of trade is said to be favourable and vice than the total payments, the BOP is
versa.

termed as favourable and vice versa.

3- Goods and Services

Balance of Trade

Balance of Payment
It

It includes only (visible) goods.

includes

both

(visible

and

invisible) goods and services.

4- Revenue and Capital

Balance of Trade
It

includes

all revenue

Balance of Payment
receipts and

payments on account of imports and The

exports.

BOP

includes

all revenue

and

capitalitems.
5- Relationship
Balance of Trade

Balance of Payment
The BOP

includes

BOT also.

The BOT does not include the BOP. It is Accordingly, it is equal to the BOT plus
the part of BOP.

import & export of services.

6- Economic Position

Balance of Trade

Balance of Payment

It does not show the actual economic Balance of payment shows the real
position of a country.

economic position of a country.

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