What are the instruments used by the Central Bank to control the supply of money in any economy?

Answer Details

The Central Bank controls the money supply using two broad groups of instruments: quantitative (general) instruments and qualitative (selective) instruments.

Quantitative instruments (affect the total volume of credit):

• Open market operations (OMO): selling government securities to the public reduces the money supply; buying them back increases it.
• Bank (discount) rate: raising the rate at which the Central Bank lends to commercial banks makes borrowing dearer and contracts credit; lowering it expands credit.
• Cash reserve ratio: raising the proportion of deposits banks must keep with the Central Bank reduces their lendable funds and the money supply; lowering it does the reverse.
• Liquidity ratio: raising the minimum ratio of liquid assets banks must hold reduces the credit they can create.
• Special deposits: requiring banks to place extra deposits with the Central Bank withdraws funds from circulation.

Qualitative instruments (direct credit to particular uses):

• Selective credit control: directing banks to favour priority sectors (for example agriculture) and restrict others.
• Moral suasion: persuading and appealing to banks to follow the Central Bank's desired lending policy.
• Direct/legal directives: issuing binding instructions and setting credit ceilings on lending.