(a) Distinguish between cash ratio and special deposits. (b) Explain how cash ratio and special deposits are used as instruments of monetary policy. (c) Des...

(a) Cash ratio versus special deposits

The cash ratio (cash-reserve ratio) is the proportion of a commercial bank's total deposits that it is legally required to hold as cash reserves with the central bank. Special deposits are extra funds that the central bank calls upon commercial banks to lodge with it, over and above the normal reserves; these deposits are frozen and cannot be used for lending. In short, the cash ratio is a standing proportion of deposits, while special deposits are additional, deliberately immobilised sums.

(b) How they are used as monetary-policy instruments

Both work by altering the volume of funds banks have available for lending, and therefore the money supply:

• When the central bank raises the cash ratio, banks must keep a larger share of deposits idle, so their excess reserves and lending capacity fall; the money supply contracts. Lowering the ratio has the opposite, expansionary effect.
• When the central bank calls for special deposits, it removes cash from the banks and freezes it, directly reducing their ability to create credit and so tightening the money supply. Releasing special deposits eases credit.

Both are therefore used to curb excessive lending during inflation and to encourage lending during a slump.

(c) Two instruments of fiscal policy in West Africa

• Taxation: government varies direct and indirect taxes to influence demand; raising taxes reduces spending power to fight inflation, lowering them boosts demand.
• Government expenditure: government raises or lowers its own spending on projects and services to expand or contract aggregate demand (often combined with public borrowing and a budget surplus or deficit).