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Difficulty: HardCentral Bank: Functions and Monetary Policy Instruments

During a period of severe inflation, the Central Bank of Nigeria seeks to curb general money supply and commercial bank credit expansion while concurrently guaranteeing that commercial banks channel funding to the agricultural sector. Which pair of monetary policy tools should the central bank deploy to achieve these dual objectives?

  1. Selling Treasury bills through Open Market Operations and imposing selective credit quotas in favor of agricultureAnswer
  2. B
    Lowering the Cash Reserve Ratio and applying moral suasion to persuade commercial banks to restrict loans
  3. C
    Reducing the bank rate and selling government securities on the open market
  4. D
    Establishing special margin requirements on commercial loans and issuing moral suasion guidelines only

Answer

The central bank should sell Treasury bills through Open Market Operations to absorb bank reserves, and impose selective credit quotas to direct lending toward agriculture.
To combat inflation while supporting a targeted economic sector, a central bank must combine a contractionary quantitative tool with a selective credit control tool. Selling Treasury bills in Open Market Operations absorbs cash reserves from commercial banks, curbing general money creation. Concurrently, sectoral credit quotas serve as a selective (qualitative) tool that mandates commercial banks to allocate a specific percentage of their loan portfolios to agriculture.

Step-by-Step Solution

1
Analyze the primary objective of reducing overall money supply during inflation.
Identify that a contractionary quantitative monetary instrument is required to absorb liquidity from commercial banks.
Quantitative controls alter total bank reserves across the economy. Selling government securities via Open Market Operations (OMO) directly drains commercial bank reserves, curtailing general credit creation.
2
Analyze the secondary objective of directing credit specifically to the agricultural sector.
Identify that a qualitative or selective monetary policy tool is required.
Selective instruments (like sectoral credit directives or quotas) do not target total money volume but control the distribution and allocation of credit to preferred sectors.
3
Synthesize the two policy mechanisms to select the correct policy mix.
Pairing OMO security sales (quantitative reduction of money supply) with selective credit quotas (qualitative allocation of funds to agriculture) fulfills both macroeconomic aims.
This combination simultaneously reduces overall inflationary pressures while protecting strategic real-sector production.

Key Concept

Distinction between Quantitative and Selective Monetary Policy Instruments
Estimated Time:2m 0s
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Topics

Central Bank: Functions and Monetary Policy Instruments

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