Explain the various qualitative and quantitative instruments used by the central bank in controlling the money supply during the times of a) excess demand/inflation b) deficient demand/deflation.

Solution:
Qualitative and quantitative instruments used by the central bank during the times of inflation:
(a) Bank rate:
It is the rate charged on the loans offered by the Central bank to the commercial banks without any collateral. Bank rate is increased at the time of inflation to reduce the money supply in the economy.
(b) Repo rate: Repo rate is the rate charged on the secured loans offered by the Central bank to the commercial banks that includes collateral. Repo rate is increased at the time of inflation to control the supply of money.
(c) Open Market Operations: Open market operation (OMO) is a monetary policy by the central bank in which the bank deals in the sale and purchase of securities in the open market to control the supply of money in the economy. During inflation, central bank sells the securities which resultantly soaks liquidity from the economy. 
(d) Statutory Liquidity Ratio (SLR): It refers to liquid assets that the commercial banks must hold on daily basis as a percentage of their total deposits. SLR is increased at the time of inflation to reduce the money supply in the economy by reducing the credit by the commercial banks.
(e) Cash Reserves Ratio (CRR): It is the proportion  of total deposits of the commercial banks which they must  keep as cash reserves with the central bank. CRR is increased at the time of inflation to reduce the money supply in the economy by reducing the credit by the commercial banks.
(f) Margin Requirement: 
Margin Requirement: It refers to the difference between the current value of the collateral and the value of loan granted. Margin requirement is increased during inflation so that demand for loans in decreased.
(g) 
Rationing of Credit: Rationing of credit refers to fixation of credit quotas for different business activities which is introduced when the flow of credit is to be checked particularly for speculative activities in the economy. 
(h) Moral Suasion: The central bank makes the member bank agree through persuasion or pressure to follow its directives which is generally not ignored by the member banks. The banks are advised to restrict the flow of credit during inflation. 

Qualitative and quantitative instruments used by the central bank during the times of deflation:
(a) Bank rate:
Bank rate is decreased at the time of deflation to increase the money supply in the economy.
(b) Repo rate: Repo rate is the rate charged on the secured loans offered by the Central bank to the commercial banks that includes collateral. Repo rate is decreased at the time of  deflation.
(c) Open Market Operations: During deflation, central bank purchases the securities which resultantly increases the availability of cash in market.
​​​​​​​(d) Statutory Liquidity Ratio (SLR): SLR is decreased at the time of deflation to increase the money supply in the economy.
(e) Cash Reserves Ratio (CRR): It is the proportion  of total deposits of the commercial banks which they must  keep as cash reserves with the central bank. CRR is decreased at the time of deflation to increase the money supply in the economy.
(f) Margin Requirement: 
Margin requirement is decreased during deflation so that public can take more and more  loans.
(g) 
Rationing of Credit: Rationing of credit refers to fixation of credit quotas for different business activities which is introduced when the flow of credit is to be checked particularly for speculative activities in the economy. 
(h) Moral Suasion: The central bank makes the member bank agree through persuasion or pressure to follow its directives which is generally not ignored by the member banks. The banks are advised to increase the flow of credit during deflation. 

 

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