Monetary Policy Techniques:

General and Selective Methods

Broadly, instruments or techniques of monetary policy can be
divided into two categories:
(A) Quantitative or General Methods.

(B) Qualitative or Selective Methods.

A. Quantitative or General Methods:

1. Bank Rate or Discount Rate:
Bank rate refers to that rate at which a central bank is ready to lend
money to commercial banks or to discount bills of specified types.

Thus by changing the bank rate, the credit and further money supply
can be affected. In other words, rise in bank rate increases rate of
interest and fall in bank rate lowers rate of interest.

During the course of inflation, monetary authority raises the bank rate
to curb inflation. Higher bank rate will check the expansion of credit of
commercial banks. They will be left with less resources which would
restrict the credit creating capacity of the bank. On the contrary, during
depression, bank rate is lowered, business community will prefer to
have more and more loans to pull the economy out of depression.
Therefore, bank rate or discount rate can be used in both types of
situation i.e. inflation and depression.

2. Open Market Operations:

By open market operations, we mean the sale or purchase of securities.
As is known that the credit creating capacity of the commercial banks
depend on the cash reserves of the banks. In this way, the monetary
authority (Central Bank) controls the credit by affecting the base of the
credit-creation by the commercial banks. If the credit is to be decreased
in the country, the central bank begins to sell securities in the open
market.
This will result to reduce money supply with the public as they will
withdraw their money with the commercial banks to purchase the
securities. The cash reserves will tend to diminish. This happens in the
period of inflation. During depression when prices are falling, the
central bank purchases securities resulting in expansion of credit and
aggregate demand,

3. Variable Reserve Ratio:

The commercial banks have to keep given percentage as cash-reserve
with the central bank. In lieu of that cash ratio, it allows commercial
banks to contract or expand its credit facility. If the central bank wants
to contract credit (during inflation period) it raises the cash reserve
ratio.

As a result, commercial banks are left with less amount of deposits.

Their favour to credit is curtailed. If there is depression in the economy,
the reserve ratio is reduced to raise the credit creating capacity of
commercial banks. Therefore, variable reserve ratio can be used to
affect commercial banks to raise or reduce their credit creation capacity.

4. Change of Liquidity:
According to this method, every bank is required to keep a certain
proportion of its deposits as cash with it. When the central bank wants
to contract credit, it raises its liquidity ratio and vice versa.

B. Qualitative or Selective Methods:

1. Change in Marginal Requirements:
Under this method, the central bank effects a change in the marginal
requirement to control and release funds. When the central bank feels
that prices are rising on account of stock-piling of some commodities by
the traders, then the central bank controls credit by raising the marginal
requirements. (Marginal requirement is the difference between the
market value of the assets and its maximum loan value). Let us suppose,
a borrower pledged goods worth Rs. 1000 as security with a bank and
gets a loan amounting to Rs. 800.
Thus marginal requirement is Rs. 200 or 20 percent. If this margin is
raised, the borrower will have to pledge goods of greater value to secure
loan of a given amount. This would reduce money supply and inflation
would be curtailed. Similarly, in case of depression, central bank
reduces margin requirement. This will in turn raise the credit creating
capacity of the commercial banks. Therefore, margin requirement is a
significant tool in the hands of central authority during inflation and
depression.

2. Regulation of consumer credit:

During inflation, this method is followed to control excess spending of
the consumers. Generally the hire purchase facilities or installment
methods are used to reduce to the minimum to curb the expenditure on
consumption. On the contrary, during depression period, more credit
facilities are allowed so that consumer may spend more and more to
pull the economy out of depression.

3. Direct Action:
This method is adopted when some commercial banks do not co-
operate with the central bank in controlling the credit. Thus, central
bank takes direct action against the defaulter. The central bank may
take direct action in a number of ways as under.

(i) It may refuse rediscount facilities to those banks who are not
following its directions.

(ii) It may follow similar policy with the bank seeking accommodation
in excess of its capital and reserves.

(iii) It may change rates over and above the bank rate.

(iv) Any other strict restrictions on the defaulter institution.

4. Rationing of the credit:

Under this method, the central bank fixes a limit for the credit facilities
to commercial banks. Being the lender of the last resort, central bank
rations the available credit among the applicants.
Generally, rationing of credit is done by the following four
ways.
(i) Central bank can refuse loan to any bank.

(ii) Central bank can reduce the amount of loans given to the banks.

(iii) Central bank can fix quota of the credit.

(iv) Central bank can determine the limit of the credit granted to a
particular industry or trade.

5. Moral Persuasion or Advice:

In the recent years, the central bank has used moral suasion also as a
tool of credit control. Moral suasion is a general term describing a
variety of informal methods used by the central bank to persuade
commercial banks to behave in a particular manner. Moral suasion
takes the form of Directive and Publicity.

In-fact, moral persuasion is a sort of advice. There is no element of

compulsion in it. The central bank focuses on the dangerous
consequences of the credit expansion and seeks their co-operation. The
effectiveness of this method depends on the prestige enjoyed by the
central bank on the degree of co-operation extended by the commercial
banks.

6. Publicity:
Publicity is also another qualitative technique. It means to force them
to follow only that credit policy which is in the interest of the economy.
The publicity generally takes the form of periodicals and journals. The
banks are not kept informed about the type of monetary policy, the
central bank regards goods for the economy. Therefore, the main aim of
this method is to bring the banking community under the pressure of
public opinion.