Monetary policy instruments

Monetary policy instruments
See also

Monetary policy instruments are tools by which the central bank implements monetary policy goals. Thanks to these tools, it influences the scale of money creation on the market. The adopted strategy and objectives are the main determinants of the choice of a set of instruments in the monetary policy pursued. This selection is also dependent on the country's economic situation, the stage of development of the money market and the adopted ad hoc policy of the so-called easy or difficult money.

Breakdown of monetary policy instruments[edit]

Criteria for the division of instruments Types of the instrument
The manner of central bank influence Direct and indirect control instruments
Position assumed by the central bank towards commercial banks Measures of administrative and market influence
Types of instruments Instruments of quantitative and qualitative control
Area of ​​impact of instruments Measures of general scope and measures acting selectively

Types of monetary policy instruments[edit]

  • Direct control (administrative control)

They directly regulate the prices of financial instruments, the size of deposits and loans granted by imposing restrictions on financial institutions in the form of directives and ordinances. These include limiting loans and administrative interest rate controls. They are used in countries with underdeveloped capital market as well as during crises. Negative impact on competitiveness, lack of synchronization with the conditions prevailing on the money market made central banks stop using them by switching to market-based instruments.

  • Instruments for indirect control (market)

These instruments are used by the central banks of developed countries to shape the short-term interest rate of the interbank market. These include: open market operations, deposit and credit operations, mandatory reserves. The condition for their application is the functioning of an effective money market on which they interact.

  • Quantitative instruments

Tools directly targeted at changes in the size of the cash flow, the liquidity of the banking system or the size of the loan, i.e. the system of minimum reserves, interest rates applied by the central bank, open market operations and credit ceilings.

Tools affecting interest rates, interest rates and interest rates, as well as the terms of granting loans through the banking system. These include maximum loan payment terms, defining the purposes for which loans can be granted, formal requirements for bills accepted for discount, siblings of securities used in open market operations.

  • General control instruments

Tools that affect simultaneously and uniformly the entire banking sector. These include open market operations, mandatory reserves and the discount rate policy of the central bank.

  • Instruments of selective control

Tools that interact selectively, usually refer to individual financial institutions. They are used with varying intensity in relation to various financial institutions.

Types of market instruments in monetary policy[edit]

  • Open market operations

Purchase and sale transactions of short-term securities between the central bank and commercial banks, on the initiative of the central bank. The basic tool in securities purchase transactions is the so-called interest rate the reference rate thanks to which the central bank influences the price of the loan on the interbank market. There are distinguished conditional and unconditional purchase and sale transactions.

The conditional purchase (repo) transaction consists in the purchase by the central bank of securities at a specified price from commercial banks, obliging them to repurchase them at a fixed time and at a specified higher price. Thus, it grants commercial banks short-term loans against securities in the situation of a shortage of liquidity in the banking sector. The sale repo (reverse repo) operation involves the central bank selling securities to commercial banks, obliging them to resale at a specified time and price. These are short-term transactions with a maturity of up to 15 days. The central bank takes such action in the situation of excessive money supply, counteracting the reduction of interbank interest rates. They precisely shape the money supply, affecting the economy in a gentle and fluid manner. They are the most important and the most widely used monetary policy instrument by central banks around the world.

  • Deposit and credit operations

Refinancing on the initiative of commercial banks with the central bank. The classic form of credit is a re-discount loan and a lombard loan. As a result of widespread use of open market operations, they have become less important and are now used as an auxiliary instrument, used sporadically in the case of large surpluses or shortages of the banking sector liquidity, when it is impossible to obtain funds on the interbank market. Thus, they constitute a last resort loan for commercial banks. They can be credited directly by taking a loan against short-term securities or by re-discounting bills of exchange.

  • Reserve requirement

This is the minimum value of funds that a commercial bank is required to maintain on a current account with a central bank, expressed as a percentage of the total amount of contributions made at a given time by customers of this bank. This instrument shapes the money supply of the banking sector and stabilizes short-term interest rates on the interbank market. By changing the required level of required reserves, the central bank encourages commercial banks to increase or decrease lending. It is a very effective instrument because a small increase in the reserve rate leads to a relatively large impact of money on the central bank account and freezing them can not be used often because it destabilizes the banking system. It can be used as a complementary tool for monetary policy.