The use of the bank rate, cash ratio, and open market operations is associated with monetary policy.
Monetary policy refers to the actions taken by a central bank, such as the Federal Reserve in the United States, to manage the money supply and influence the overall economy. The main goal of monetary policy is to achieve price stability, promote economic growth, and control inflation.
1. Bank Rate: The bank rate is the interest rate at which the central bank lends money to commercial banks. By increasing or decreasing the bank rate, the central bank can influence the cost of borrowing for commercial banks. When the central bank raises the bank rate, borrowing becomes more expensive, which can reduce spending and control inflation. Conversely, when the central bank lowers the bank rate, borrowing becomes cheaper, encouraging spending and stimulating economic activity.
2. Cash Ratio: The cash ratio, also known as the reserve requirement or reserve ratio, is the percentage of deposits that commercial banks are required to hold as reserves. By adjusting the cash ratio, the central bank can control the amount of money that banks can lend out. Increasing the cash ratio means banks must hold more reserves, limiting the amount of money available for lending. This helps control inflation and prevents excessive lending. Conversely, lowering the cash ratio increases the money available for lending, stimulating economic activity.
3. Open Market Operations: Open market operations refer to the buying and selling of government securities, such as bonds, by the central bank in the open market. When the central bank wants to increase the money supply, it buys government securities from commercial banks, injecting money into the economy. This stimulates lending and spending. On the other hand, when the central bank wants to decrease the money supply, it sells government securities, absorbing money from the economy and reducing lending and spending.
Together, these tools (bank rate, cash ratio, and open market operations) are used by the central bank to manage the money supply, regulate interest rates, and influence economic activity. By adjusting these factors, the central bank can implement monetary policy to stabilize prices, promote economic growth, and control inflation.