Monetary policy is concerned with the changes in the supply of money and credit.

It refers to the policy

measures undertaken by the government or the central bank to influence the availability, cost and use
of money and credit with the help of monetary techniques to achieve specific objectives. Monetary
policy aims at influencing the economic activity in the economy mainly through two major variables, i.e.,
(a) money or credit supply, and (b) the rate of interest.

OBJECTIVES OF MONETARY POLICY

The primary objectives of monetary policies are:

Price Stability:
One of the policy objectives of monetary policy is to stabilise the price
level. Both economists and laymen favour this policy because
fluctuations in prices bring uncertainty and instability to the economy.
Full Employment

Monetary policies can influence the level of unemployment in the economy. For
example, an expansionary monetary policy generally decreases unemployment
because the higher money supply stimulates business activities that lead to the
expansion of the job market.

Faster Economic Growth:

Monetary policy can promote faster economic growth by making credit
cheaper and more readily available. Easy availability of credit at low
rates of interest stimulates investment or expansion of society’s
production capacity. This in its turn, enables the economy to grow
faster than before.
 Currency exchange rates

Using its authority, a central bank can regulate the exchange rates between
domestic and foreign currencies. For example, the central bank may increase the
money supply by issuing more currency. In such a case, the domestic currency
becomes cheaper relative to its foreign counterparts.

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Instruments of Monetary Policy:

The instruments of monetary policy are of two types: first,

quantitative, general or indirect; and second, qualitative,
selective or direct. They affect the level of aggregate demand
through the supply of money, cost of money and availability of
credit. Of the two types of instruments, the first category
includes bank rate variations, open market operations and
changing reserve requirements. They are meant to regulate the
overall level of credit in the economy through commercial banks.
The selective credit controls aim at controlling specific types of
credit. They include changing margin requirements and
regulation of consumer credit. 

the various instruments used by the BSP to achieve the desired level of money supply. These
include (a) raising/reducing the BSP's policy interest rates; (b) increasing/decreasing the reserve
requirement; (c) encouraging/discouraging deposits in the overnight deposit facilities (ODF) and
term deposit facilities (TDF) by banks; (d) increasing/decreasing its rediscount rate on loans
extended to banking institutions on a short-term basis against eligible collaterals of banks’
borrowers; and (e) outright sales/purchases of the BSP’s holdings of government securities. The
BSP’s main policy instrument used to signal the stance of monetary policy is the overnight
reverse repurchase (borrowing) rate.

BSP & THE BANKING SYSTEM

Bangko Sentral ng Pilipinas (central Bank of PH) are mandated
to assure that the Philippines have a stable and healthy financial
system. They oversee the operations of the entire financial system and
mandate the rules, regulations, and monetary policies that will help
their respective countries maintain a healthy and stable economy.

A central bank is also a “banker” to banks providing various

services to banks, helping them collect and clear checks and loaning
them funds as needed. As a lender and a regulator, the central bank
oversees the health of the banking system.
The BSP monitors and compiles various indicators on the Philippine banking system. The Philippine
banking system is composed of universal and commercial banks, thrift banks, rural and cooperative
banks.
Universal and commercial banks represent the largest single group, resource-wise, of financial
institutions in the country. They offer the widest variety of banking services among financial institutions.
In addition to the function of an ordinary commercial bank, universal banks are also authorized to engage
in underwriting and other functions of investment houses, and to invest in equities of non-allied
undertakings.

The thrift banking system is composed of savings and mortgage banks, private development banks,
stock savings and loan associations and microfinance thrift banks. Thrift banks are engaged in
accumulating savings of depositors and investing them. They also provide short-term working capital and
medium- and long-term financing to businesses engaged in agriculture, services, industry and housing,
and diversified financial and allied services, and to their chosen markets and constituencies, especially
small- and medium- enterprises and individuals.

Rural and cooperative banks are the more popular type of banks in the rural communities. Their role is to
promote and expand the rural economy in an orderly and effective manner by providing the people in the
rural communities with basic financial services. Rural and cooperative banks help farmers through the
stages of production, from buying seedlings to marketing of their produce. Rural banks and cooperative
banks are differentiated from each other by ownership. While rural banks are privately owned and
managed, cooperative banks are organized/owned by cooperatives or federation of cooperatives.

The BSP likewise releases selected statistics on non banks with quasi-banking functions . This group
consists of institutions engaged in the borrowing of funds from 20 or more lenders for the borrower's
own account through issuances, endorsement or assignment with recourse or acceptance of deposit
substitutes for purposes of relending or purchasing receivables and other obligations.

Open Market Operations

Open market operations refer to sale and purchase of securities in the
money market by the central bank. When prices are rising and there is
need to control them, the central bank sells securities. The reserves of
commercial banks are reduced and they are not in a position to lend
more to the business community.

Further investment is discouraged and the rise in prices is checked.

Contrariwise, when recessionary forces start in the economy, the
central bank buys securities. The reserves of commercial banks are
raised. They lend more. Investment, output, employment, income and
demand rise and fall in price is checked
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instruments-of-monetary-policy/11134

Types of Monetary Policy

Expansionary Monetary Policy

This is a monetary policy that aims to increase the money supply in the
economy by decreasing interest rates, purchasing government securities by
central banks, and lowering the reserve requirements for banks. An
expansionary policy lowers unemployment and stimulates business activities
and consumer spending. The overall goal of the expansionary monetary policy
is to fuel economic growth. However, it can also possibly lead to higher
inflation.

 Central banks use contractionary monetary policy to reduce inflation. They

reduce the money supply by restricting the volume of money banks can lend. The
banks charge a higher interest rate, making loans more expensive. Fewer
businesses and individuals borrow, slowing growth.

Expansionary Monetary Policy – monetary policy setting that intends to increase the level of
liquidity/money supply in the economy and which could also result in a relatively higher inflation path for
the economy. Examples are the lowering of policy interest rates and the reduction in reserve
requirements.

Expansionary monetary policy tends to encourage economic activity as more funds are made available
for lending by banks. This, in turn, increases aggregate demand which could eventually fuel inflation
pressures in the domestic economy.

Contractionary Monetary Policy

The goal of a contractionary monetary policy is to decrease the money supply

in the economy. It can be achieved by raising interest rates, selling
government bonds, and increasing the reserve requirements for banks. The
contractionary policy is utilized when the government wants to control
inflation levels.

Central banks use expansionary monetary policy to lower unemployment and

avoid recession. They increase liquidity by giving banks more money to lend.
Banks lower interest rates, making loans cheaper. Businesses borrow more to
buy equipment, hire employees, and expand their operations. Individuals borrow
more to buy more homes, cars, and appliances. That increases demand and
spurs economic growth.

  
 Contractionary Monetary Policy - monetary policy setting that intends to decrease the level of
liquidity/money supply in the economy and which could also result in a relatively lower inflation
path for the economy. Examples of this are increases in policy interest rates and reserve
requirements. Contractionary monetary policy tends to limit economic activity as less funds are
made available for lending by banks. This, in turn, lowers aggregate demand which could
eventually temper inflation pressures in the domestic economy.

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THE TECHNIQUES OF MONETARY CONTROL

Broadly, instruments or techniques of monetary policy can

be divided into two categories:
(A) Quantitative or General Methods.

1. Bank Rate or Discount Rate:

Bank rate refers to that rate at which a central bank is ready to lend
money to commercial banks or to discount bills of specified types.

Thus by changing the bank rate, the credit and further money supply
can be affected. In other words, rise in bank rate increases rate of
interest and fall in bank rate lowers rate of interest.

During the course of inflation, monetary authority raises the bank rate
to curb inflation. Higher bank rate will check the expansion of credit of
commercial banks. They will be left with less resources which would
restrict the credit creating capacity of the bank. On the contrary,
during depression, bank rate is lowered, business community will
prefer to have more and more loans to pull the economy out of
depression. Therefore, bank rate or discount rate can be used in both
types of situation i.e. inflation and depression.

2. Open Market Operations:

By open market operations, we mean the sale or purchase of
securities. As is known that the credit creating capacity of the
commercial banks depend on the cash reserves of the banks. In this
way, the monetary authority (Central Bank) controls the credit by
affecting the base of the credit-creation by the commercial banks. If
the credit is to be decreased in the country, the central bank begins to
sell securities in the open market.

This will result to reduce money supply with the public as they will
withdraw their money with the commercial banks to purchase the
securities. The cash reserves will tend to diminish. This happens in the
period of inflation. During depression when prices are falling, the
central bank purchases securities resulting in expansion of credit and
aggregate demand,

3. Variable Reserve Ratio:

The commercial banks have to keep given percentage as cash-reserve
with the central bank. In lieu of that cash ratio, it allows commercial
banks to contract or expand its credit facility. If the central bank wants
to contract credit (during inflation period) it raises the cash reserve
ratio.

As a result, commercial banks are left with less amount of deposits.

Their favour to credit is curtailed. If there is depression in the
economy, the reserve ratio is reduced to raise the credit creating
capacity of commercial banks. Therefore, variable reserve ratio can be
used to affect commercial banks to raise or reduce their credit creation
capacity.
4. Change of Liquidity:
According to this method, every bank is required to keep a certain
proportion of its deposits as cash with it. When the central bank wants
to contract credit, it raises its liquidity ratio and vice versa.

B. Qualitative or Selective Methods:

1. Change in Marginal Requirements:
Under this method, the central bank effects a change in the marginal
requirement to control and release funds. When the central bank feels
that prices are rising on account of stock-piling of some commodities
by the traders, then the central bank controls credit by raising the
marginal requirements. (Marginal requirement is the difference
between the market value of the assets and its maximum loan value).
Let us suppose, a borrower pledged goods worth Rs. 1000 as security
with a bank and gets a loan amounting to Rs. 800.

Thus marginal requirement is Rs. 200 or 20 percent. If this margin is

raised, the borrower will have to pledge goods of greater value to
secure loan of a given amount. This would reduce money supply and
inflation would be curtailed. Similarly, in case of depression, central
bank reduces margin requirement. This will in turn raise the credit
creating capacity of the commercial banks. Therefore, margin
requirement is a significant tool in the hands of central authority
during inflation and depression.

2. Regulation of consumer credit:

During inflation, this method is followed to control excess spending of
the consumers. Generally the hire purchase facilities or installment
methods are used to reduce to the minimum to curb the expenditure
on consumption. On the contrary, during depression period, more
credit facilities are allowed so that consumer may spend more and
more to pull the economy out of depression.

3. Direct Action:
This method is adopted when some commercial banks do not co-
operate with the central bank in controlling the credit. Thus, central
bank takes direct action against the defaulter. The central bank may
take direct action in a number of ways as under.

(I)It may refuse rediscount facilities to those banks who are not
following its directions.

(ii) It may follow similar policy with the bank seeking accommodation
in excess of its capital and reserves.

(iii) It may change rates over and above the bank rate.

(iv) Any other strict restrictions on the defaulter institution.

4. Rationing of the credit:

Under this method, the central bank fixes a limit for the credit
facilities to commercial banks. Being the lender of the last resort,
central bank rations the available credit among the applicants.

Generally, rationing of credit is done by the following four

ways.
(i) Central bank can refuse loan to any bank.

(ii) Central bank can reduce the amount of loans given to the banks.

(iii) Central bank can fix quota of the credit.

(iv) Central bank can determine the limit of the credit granted to a
particular industry or trade.

5. Moral Persuasion or Advice:

In the recent years, the central bank has used moral suasion also as a
tool of credit control. Moral suasion is a general term describing a
variety of informal methods used by the central bank to persuade
commercial banks to behave in a particular manner. Moral suasion
takes the form of Directive and Publicity.

In-fact, moral persuasion is a sort of advice. There is no element of

compulsion in it. The central bank focuses on the dangerous
consequences of the credit expansion and seeks their co-operation.
The effectiveness of this method depends on the prestige enjoyed by
the central bank on the degree of co-operation extended by the
commercial banks.

6. Publicity:
Publicity is also another qualitative technique. It means to force them
to follow only that credit policy which is in the interest of the economy.
The publicity generally takes the form of periodicals and journals. The
banks are not kept informed about the type of monetary policy, the
central bank regards goods for the economy. Therefore, the main aim
of this method is to bring the banking community under the pressure
of public opinion.