Examkin

Question

Difficulty: MediumCentral Bank: Functions and Monetary Policy Instruments

During a period of rapid economic expansion, the Central Bank observes rising demand-pull inflation and seeks to immediately restrict commercial bank liquidity without engaging in the buying or selling of treasury bills in the open market. Which of the following monetary policy measures would directly accomplish this goal?

  1. Increasing the Cash Reserve RatioAnswer
  2. B
    Issuing sectoral credit guidelines to prioritize agricultural loans
  3. C
    Lowering the minimum rediscount rate on commercial bills
  4. D
    Employing moral suasion through informal meetings with bank executives

Answer

Increasing the Cash Reserve Ratio directly restricts commercial bank liquidity by locking up a higher percentage of total bank deposits as mandatory reserves with the central bank, thereby reducing loanable funds without resorting to open market operations.
Increasing the Cash Reserve Ratio requires commercial banks to lock away a larger fraction of their total deposits with the central bank. This directly diminishes their excess liquidity and credit-creation potential without necessitating open market sales or purchases of securities.

Step-by-Step Solution

1
Identify the central economic problem and constraint
The central bank needs to curb inflation by reducing commercial bank lending capacity without utilizing Open Market Operations (buying or selling treasury bills).
Understanding the policy objective and technical constraints narrows down the appropriate monetary policy instrument.
2
Evaluate quantitative versus selective monetary policy instruments
Quantitative instruments (like cash reserve ratio, liquidity ratio, and rediscount rate) alter the overall liquidity pool, whereas selective tools direct credit allocation.
Direct overall liquidity restriction requires a quantitative measure.
3
Determine the impact of raising the Cash Reserve Ratio
Increasing the cash reserve ratio forces banks to transfer a larger share of customer deposits into non-spendable central bank reserve accounts, instantly shrinking excess reserves available for lending.
This directly reduces liquidity and credit expansion without requiring open market transactions.

Key Concept

Monetary Policy Instruments: Quantitative vs. Selective Tools
Estimated Time:1m 0s
Rate this question

Topics

Central Bank: Functions and Monetary Policy Instruments

More questions from this topic