List all the tools of monetary policy List two monetary poli

List all the tools of monetary policy. List two monetary policy targets. List two ultimate goals of monetary policy. B) Explain how the bank credit channels (two channels) of monetary policy transmission operate. Illustrate with the scenario where the Federal Reserve Bank undertakes an open market purchase. C) What are some of the conditions for effectiveness of the bank credit channels of monetary policy transmission? List at least two and explain why they are necessary.

Solution

A.Tools of monetary policy:

Bank rate policy

Open market operations

Changes in Reserve ratio

Selective credit controls.

Reserve ratio was first suggested by Keynes in his Treaty of Money and the USA was the first to adopt it as a monetary device. When prices are rising, central bank increases the reserve ratio which forces banks to keep more with the central bank. The volume of investment, output, and employment are adversely affected. The reverse action would enable banks to lend more and the economic activity is favourably affected.

Bank rate is the minimum lending rate of the central bank. During inflation, the bank rate is increased and commercial banks borrow less from it. In turn, commercial banks increase their lending rates offering less loans to the customers.

B. There are only two classes of assets, one is money and the other form of assets. Reserves have value because they are held against transaction deposits which can be issued only by banks. A decline in reserves results in a fall in transactions deposit, which drives up the nominal interest rate. In the Keynesian IS-LM model, a rise in the nominal interest rate translates into a rise in the real interest rate which depresses aggregate demand.

C. From the interest rate point of view, prices must not adjust fully to a change in money supply. Money is not neutral, at least, in the short-run. Open market operations must affect the supply of bank loans, and loans and bonds must not be perfect substitutes as a source of credit.

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