Monetary Policy and its Instruments | Economics for JAMB PDF Download

Monetary Policy

• Monetary policy refers to the actions taken by the central bank to manage and control the money supply and interest rates in an economy.
• It aims to achieve price stability, control inflation, promote economic growth, and maintain financial stability.

Cash Reserve Ratio (CRR)

• CRR is the percentage of a bank's total deposit liabilities that it must hold as reserves in the form of cash with the central bank.
• It is used to regulate the liquidity in the banking system.
• When the central bank increases the CRR, it reduces the lendable resources of banks, restricting the availability of credit and controlling inflation.
• Conversely, a decrease in the CRR increases lendable resources, stimulating credit creation and economic growth.

Bank Rate

• Bank rate refers to the interest rate at which the central bank lends to commercial banks for long-term periods.
• It influences the cost of borrowing and directly affects interest rates in the economy.
• When the central bank increases the bank rate, it becomes more expensive for commercial banks to borrow, which reduces the money supply and controls inflation.
• Conversely, a decrease in the bank rate makes borrowing cheaper, stimulates lending, and promotes economic growth.

Repo Rate

• Repo rate is the rate at which commercial banks borrow funds from the central bank for short-term periods by selling government securities.
• It acts as a tool for liquidity management in the banking system.
• An increase in the repo rate makes borrowing more expensive for banks, leading to reduced liquidity and tighter credit conditions.
• A decrease in the repo rate makes borrowing cheaper, increasing liquidity and stimulating credit creation.

Reverse Repo Rate

• Reverse repo rate is the rate at which the central bank borrows funds from commercial banks by purchasing government securities.
• It is used to absorb excess liquidity from the banking system.
• An increase in the reverse repo rate incentivizes banks to lend more to the central bank, reducing the money supply and controlling inflation.
• A decrease in the reverse repo rate reduces the attractiveness of lending to the central bank, leading to increased liquidity in the banking system.

Statutory Liquidity Ratio (SLR)

• SLR is the percentage of a bank's net demand and time liabilities that it must maintain in the form of liquid assets such as cash, gold, or government securities.
• It ensures the solvency and liquidity of banks.
• When the central bank increases the SLR, banks are required to maintain a higher proportion of their deposits as liquid assets, reducing their lendable resources.
• Conversely, a decrease in the SLR increases the lendable resources of banks, promoting credit creation and economic growth.

Open Market Operations (OMOs)

• OMOs involve the buying and selling of government securities by the central bank in the open market.
• It is used to regulate the money supply and interest rates.
• When the central bank buys government securities through OMOs, it injects money into the economy, increasing the money supply and stimulating economic growth.
• Conversely, when the central bank sells government securities, it absorbs money from the economy, reducing the money supply and controlling inflation.