Explain the various qualitative and quantitative instruments used by t...
Qualitative Instruments:
1. Reserve Requirements: The central bank can use reserve requirements to influence the money supply. By increasing the reserve requirements, the central bank can reduce the money supply, as banks will have to hold a larger portion of their deposits in reserves rather than lending them out.
2. Moral Suasion: Moral suasion refers to the persuasive measures taken by the central bank to influence the behavior of commercial banks. The central bank can use moral suasion to encourage banks to reduce lending or increase their reserves, thereby controlling the money supply.
3. Credit Rationing: The central bank can implement credit rationing measures to control the money supply. This involves setting limits on the amount of credit that banks can extend to borrowers. By reducing credit availability, the central bank can reduce the money supply.
Quantitative Instruments:
1. Open Market Operations: Open market operations involve the buying and selling of government securities by the central bank in the open market. If there is excess demand/inflation, the central bank can sell government securities to commercial banks and the public, thereby reducing the money supply.
2. Discount Rate: The discount rate is the interest rate charged by the central bank on loans provided to commercial banks. If there is excess demand/inflation, the central bank can increase the discount rate, making borrowing more expensive for commercial banks. This discourages borrowing and reduces the money supply.
3. Repo Rate: The repo rate is the rate at which the central bank lends money to commercial banks for short periods. If there is excess demand/inflation, the central bank can increase the repo rate, making borrowing more expensive for commercial banks. This reduces the money supply as banks are less likely to borrow from the central bank.
4. Liquidity Adjustment Facility (LAF): LAF allows banks to borrow from the central bank to meet their short-term liquidity needs. If there is deficient demand/deflation, the central bank can lower the repo rate under LAF, making borrowing cheaper for commercial banks. This increases the money supply as banks are more likely to borrow from the central bank.
Conclusion: The central bank uses a combination of qualitative and quantitative instruments to control the money supply during times of excess demand/inflation or deficient demand/deflation. These instruments provide the central bank with tools to influence the behavior of commercial banks and the overall availability of credit in the economy, thereby impacting the money supply.
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