Central Banking & the

Monetary Policy
 Role of Central Bank
• Central bank plays a critical role in every
transaction, business and daily activities,
whether it is Economic activity or Individual
activity (saving schemes or return matters)

• Central banks monitors the purchase and

repurchase so that loss would not be there in
the exchange rates.
 Role of Central Bank
• Central bank gives money to commercial banks
in the time of crises to avoid panic life situations
in the markets.

• Reserves are just like savings help to fall back

upon from difficult or contingent situations.

• Banks it self has no money , for this there are

some legislations required, that are issued in the
form of Prudential regulations by central Bank
for determining credit policy.
 Role of Central Bank
• The central bank has a number of policy instruments that can
effect the major objectives of monetary policy:

– Stability of prices

– Stability of exchange rate

• Central banks can focus on:

– Quantitative monetary policy: central banks regulate monetary
base

– Qualitative monetary policy: central banks regulate market

interest rate and provide monetary base which respond to money
demand
Objective of Monetary Policy

• To maintain price stability is the

primary objective of the monetary
policy. ensuring price stability is
the most important contribution
that monetary policy can make to
achieve a favourable economic
environment and a high level of
employment.
 Monetary Policy Instruments
• The main monetary policy
instruments available to central bank
is
• open market operation,
• bank reserve requirement,
• interest-rate policy,
• re-lending and re-discount (including using
the term repurchase market), and
• credit policy (often coordinated with trade
policy).
 Monetary Policy Instruments
• Direct, administrative instruments:
– Credit limits
– Interest rates limits
– Liquidity rules
– Investment regulation
 Monetary Policy Instruments

• Indirect, market instruments:

– Open - Market Operations
– Legal Reserve Requirements
– Discount Rate Policy
 Legal Reserve Requirements
• All banks are required to hold a minimum
percentage of deposits as reserve.
Changes in required reserve ratios can
have an important influence on the money
supply.
• Changes in reserve requirements are
made sparingly because they present too
large change in monetary policy.
 Capital Requirement
• All banks are required to hold a
certain percentage of their assets
as capital.

• A rate which may be established by

the Central bank or banking

supervisor.
 Capital Adequacy
• Capital adequacy is important, it
is defined and regulated by the
Bank for International
Settlements, and central bank in
practice generally apply strict
rules.
 Capital Adequacy
• To enable open market operations, a
central bank must hold foreign exchange
reserves.

• It will often have some influence over any

official or mandated exchange rates:
Some exchange rates are managed, some
are market based (free float) and many
are somewhere in between ("managed
float" ).
 Reserve Requirement
• Another significant power that Central
bank hold is the ability to establish reserve
requirement for other banks.

• The other requirement is that a

percentage of liability is being held as
cash or deposited with the Central bank or
other agency , limits are set on the money
supply.
 Discount Rate Policy
• Discount rate is the interest rate at which the central
bank stands ready to lend reserves to commercial
banks.
There are the three key interest rates for the banks:
• The interest rate on the main refinancing operations.

• The rate on the deposit facility, which banks may use

to make overnight deposits.

• The rate on the marginal lending facility, which offers

overnight credit to banks .
 Expansionary Monetary Policy
• When the central bank raises the money
supply interest rates fall. The economy
moves down the money demand
schedule. Lower interest rates reduces the
costs of investment; thus higher
investment raises aggregate demand
curve.
 Tight Monetary Policy
• Central bank contracts the money supply
in response to fears of rising prices. The
lower money supply increases interest
rates. The result of a tighter monetary
policy is lower investment and decrease in
the nation’s output.
 The Monetary Transmission
Mechanism
• The monetary transmission mechanism
represents the way by which changes in
the supply of money are translated into
changes in output, employment, prices
and inflation.
 Exchange Rate
• Accordingly there are certain exchange
requirements to influence the money
supply ,some Central Banks may require
that some or all foreign exchange receipts
generally from exports be exchanged for
the local currency ,the rate that is used to
purchase local currency may be market
based or arbitrarily set by bank.
 Open - Market Operations
• Open-market operations represent purchases or
sale of government securities and treasuries to
influence the money supply.
• These operations are a central bank the most
important stabilizing instruments.
• Open market operations serve the purpose of
managing interest rate, the liquidity situation in
the market and signaling the stance of monetary
policy.
 Open Market Operations
• Through open market operations,
a central bank influences the
money supply in an economy
directly. Each time it buys
securities, exchanging money for
the security, it raises the money
supply.
 Open Market Operations
• Conversely, selling of securities
lowers the money supply.

• Buying of securities thus amounts

to printing new money while
lowering supply of the specific
security.
 Open Market Operations
• Temporary lending of money for collateral
securities ("Reverse Operations" or
"repurchase operations", otherwise known
as the "repo" market).

• These operations are carried out on a

regular basis, with fixed maturity time
periods.