monetary policy is a very effective and important tool of a
central bank of a country.central bank controls the inflation and
supply of money with this tools.
4 major tools of monetary police concerned with central bank is
explained as ahead-
- REPO RATE- repo rate is considered to be very
effective tool of the central bank. if government want to increase
money supply in the economy then it would decrease the REPO rate
and vise versa is also true.
- OPEN MARKET OPERATION-when central bank wants
to increase money supply then it starts purchasing securities from
market and as a result the cash flow increase in the money
market.and in the contrary situation the bank may sell the
securities to decrease the cash supply in the market.
- MARGIN REQUIRED- if central bank want to
increase the cash supply it may lead to decrease the margin
required as a result more liquidity would be available in the money
market.and if it wants to reduce the money supply then it would
lead to increase the margin required.
- CASH RESERVE RATIO- if central bank want to
increase the supply of money then it would lead to decrease the
cash reserve ratio as a result the bank will have more cash to lend
in the economy.and if it wants to reduce the cash supply in the
economy then it would increase the cash reserve ratio.
when central bank increases the supply of money in the economy.-
the supply curve shifts to the right and then new equilibrium point
is determined. we can get the idea from the following
diagram.in short run the supply of money is
inelastic(Only central bank can change the supply of
money)
WHEN MONEY SUPPLY IS TO BE INCREASED-
WHEN MONEY SUPPLY IS TO BE DECREASED-