DIANNE LAURICE M.

RODIS

MM – 2B

BASIC MICROECONOMICS

Explain the different tools of monetary policy.

There are five tools of monetary policy are “Required reserves, Rediscounting,
Open market operations, Selective credit control, Moral suasion.”

Required Reserves – The Bangko Sentral ng Pilipinas decides in general terms

what the lending behavior of the commercial banks should be. At any time, it may
change the percentage at which banks can lend out of their deposits. In some cases, this
percentage can be as low as 80% and in some, it may be as high as 90%. Using this
prerogative as the banker of commercial banks, the BSP, in order to influence the bank’s
lending behavior, simply requires them to keep a certain percentage of their deposits in
reserve. Thus, when it decides that lending behavior should be 80%, the reserves it
requires is 20%.

Rediscounting – In addition to required reserves, the BSP enjoys Other

prerogatives from being the bankers of banks. This prerogative is called rediscounting.
Normally, the BSP lends money to commercial banks on the basis of loan papers that
the banks have. However, it sets the limit to the funds that commercial banks can
borrow and designate the rate of interest at which it lends. The BSP rediscounts this
loan paper and the rate of interest it changes called the rediscount rate. If the BSP
wants to tighten deposits and money supply, it simply reduces the number of funds it
makes available and/or raises the rediscount rate. For example, instead of giving up to
85% of the face value of the loans, it may give only up to 65%. The rediscount rate also
provides a signal to the commercial banks on the trend of interest rates in general and is
therefore helpful when the BSP seeks to control interest rates.

Open Market Operations – Another tool of the BSP is open market operations.
The BSP, along with other commercial banks, actively participate in the purchase and
sale of government securities inactive money market. This kind of activity is
conductivity in the open money market; hence, it is called open market operations.
However, this kind of tool is good only for effecting small changes in bank loans and
money supply. To slightly tighten the money supply, the BSP sells government
securities in the money market and when it wants to ease, it buys securities. Through
the sale of government securities, the commercial banks feel the tightness in their funds
and would not be willing to lend money to clients. On the other hand, when BSP buys
securities, it injects funds to commercial banks, thus making them feel some ease in
having funds.

Selective credit control – This tool lets BSP select the kind of credit it will give to
clients. It tries to prioritize its lending activity either to production or consumption. If
it’s a priority for production, credit for consumption is lessened and gives more funds
to production and vice-versa.

Moral suasion – This tool tries to test the persuasive ability of the Chairman of
the Monetary Board and the Governor of the BSP. The BSP may hold sessions with
commercial banks and try to persuade or make suggestions to the head of commercial
banks to redirect their efforts in national development goals.