Qualitative Tools of Monetary Policy

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Central bankers around the world have similar tools at their disposal.
Central bankers around the world have similar tools at their disposal. (Image: bank city of london image by david hughes from Fotolia.com)

The qualitative tools in a central bank or a Treasury Department's monetary policy are those that affect bank lending through any means other than the expansion or constriction of the money supply itself. These may include, for example, the direct rationing of credit, changes in the marginal requirements of loans, moral suasion and publicity.

Rationing Credit

The central bank of a country typically functions as a lender of last resort. It can use this aspect of its operations to control the money supply. It could simply refuse to lend any more money to certain banks or impose a ceiling on how much it will lend per bank per fiscal quarter.

In the words of T.R. Jain and O.P. Khanna in their book "Macroeconomics," this "is relatively an old method of control of money supply," that has been used recently by central banks.

Margin Requirements

Banks or other financial institutions routinely lend money to customers to buy securities. The "margin" is the portion of a security that the regulated institution's loan is not allowed to cover. In other words, if a bank were allowed to loan up to $80 to a customer eager to buy $100 of stock, the margin would be $20. By increasing or decreasing the margin requirement, the authorities can effectively tighten the money supply.

Moral Suasion

The central bank of a country typically exercises regulatory authority over all or part of the banking industry, issuing licenses or operating permits in that capacity. This gives it leverage, as Clifford Gomez wrote in "Financial Markets, Institutions, and Financial Services" (2008) to persuade banks "not to make excessive use of Central Bank's credit facilities and also not to use the accommodation already obtained" to fuel non-essential or speculative activities by its customers.

Other Tools

Publicity can also be a tool for a central bank. If public opinion sees speculation or excessive borrowing as a bad thing, there will likely be less of it, and the central bankers can seek to influence public opinion.

Still other tools may be available, depending on the particular social and legal context in which a central bank operates.

Contrast

Such qualitative methods of the control of the money supply are generally contrasted with "quantitative" tools such as the purchase of bonds in the open market or changes in the reserve ratio.

When a central bank purchases bonds, it increases the bank account of the seller—often a bond dealer—by the amount of money equal to the price of those bonds, and thus by fiat increases the amount of money in the system. When it sells bonds, it does the reverse, with the effect of contracting the money supply.

The reserve ratio is the percentage of a commercial bank's money it is required to keep in its vaults as ready cash (to protect against bank runs, for example). The central bank can increase the money supply by lowering the reserve requirement and can decrease it by increasing that requirement.

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