Chapter 4:

The Central Bank and Monetary Policy

 Concept of Central Bank
• A national bank that provides financial and banking
services for its country's government and commercial
banking system, as well as implementing the
government's monetary policy and issuing currency.
• Central bank is an agency of government that monitoring
the operation of its financial system and controls the
growth of its money supply.
• Central bank is the bankers bank.
• In Nepal, Nepal Rastra Bank (NRB) act as a central bank.
 Functions and Objectives of Central Bank
• NRB issues notes and coins and circulate the in the economy.
• To formulate necessary monetary and foreign exchange
policies to maintain the stability in price and consolidate the
balance of payments for sustainable development of the
economy of Nepal.
• To develop a secure, healthy and efficient system of payments.
• To make appropriate supervision of the banking and financial
system in order to maintain its stability and foster its healthy
development.
• To further enhance the public confidence in Nepal's entire
banking and financial system.
• Act as banker, advisor and financial agent of Government
of Nepal.
 Different Kinds of Money
• Money has several meanings and it is of different kinds.
1. Unit of Account:- Money is the unit of the measurement of
wealth. For example, we measure the value or price of
share in Rupee. Rupee is the unit of accounting or unit of
measurement of our wealth.
2. Medium of Exchange:- Money is any Instruments that
serve as a medium of exchange. For example, we make
payment with Nepalese rupees for goods that we purchased
in Nepalese Market.
3. Store of Value:- Money functions as a store of the value of
the wealth. For example, we have a plot of land and we
want to hold the value of land not a plot of land. We can
sell the land and carry over its value from present to future.
 Monetary Policy
• The Monetary Policy is the plan of action undertaken by the
central banks, to regulate and control the demand for and supply
of money to the public so as to achieve the macroeconomic goals
controlling inflation, consumption, growth, and liquidity.
• Monetary policy is the economic strategy chosen by a
government to expand or contract the country's money supply.
Monetary policy is always concern either with the expansion of
money supply or contraction of money supply necessary to
maintain the stability in the economy.
• Supply of money affects the macro variables such as interest
rates, price, employment and standard of living of the general
public. So the central bank takes appropriate measures to keep the
money supply as per the need of the economy of the country.
• Central banks contract the volume of money supply if it
thinks that there is more money than what the economy
needs to maintain the stability in the macro variables.
Similarly, if it thinks that money supply is less than what
the economy needs, then it injects more money.
 Goals of Monetary Policy
1. Stability in Price Level
2. Higher Employment:- Attaining full employment in real
world is impossible.
3. Sustainable Economic Growth
4. Stability in interest rates
5. Stability in Foreign currency Exchange rates:
 Instruments of Monetary Policy
• Monetary policy is related to the expansion and contraction
of money supply.
• The central bank formulates and conducts the monetary
policy and uses different instruments to achieve the goal set
in the monetary policy. There are many instruments of
monetary policy available to the central banks.
• Following are the quantitative instruments of monetary
policy.
1. Reserve Requirements
• Banks have to maintain prescribed percent of deposits they
received at central bank as required reserves. For example,
in Nepal, banks have to put 4 percent of total deposits
received in local currency as the reserves with NRB.
Reserve requirement Money Supply

Reserve requirement Money Supply

2. Open Market Operations

• This is the most powerful monetary tool available to the
central bank. Open market operations mean buying and
selling the government and other securities on its own
account.
• The central bank used to sell the government securities in the
markets if it wants to contract the money supply. And central
bank buys the securities in the market and injects the new
reserve if it thinks that money supply in the market is less.
3. Open market Repurchase Agreements
• Repurchase agreement (repo) and reverse repo agreement
are the variants of open market operation.
• In repo, the central bank buys particular amount of
securities from sellers that agree to repurchase the same
securities for higher price at some future time. Future
time is usually a few weeks.
• Repurchase is a kind of loans provided by the central
bank on the collateral of the securities.
• In reverse repo, the central banks sells the securities and
makes a commitment to buy back at a higher price later.
• This tools are used to increase or decrease the reserve in
banks and financial institutions.
4. Discount rate
• The central bank provides loan to banks and other
financial institutions as banker of banks.
• Board of the central banks sets the interest rate on loans
provided to banks and other financial institutions. We call
the interest rate on such loan is discount rate.
• Rising discount rate discourage the banks to borrow and
falling discount rates encourage banks and other financial
institutions to borrow more.
 Nepal Rastra Bank and Monetary Policy in Nepal
• Nepal Rastra Bank (NRB), as mandated by the NRB Act,
2002, has been issuing monetary policy publicly since
2002/03. In addition, it has been releasing half-yearly
review of the policy since 2004/05 and quarterly review
since 2016/17.
• Major highlights of monetary policy 2019/20
• To maintain consumer price index within 6 percent for
maintaining price stability.
• Monetary management will be carried out to maintain
foreign exchange reserves sufficient to cover the
prospective imports of goods and services for at least 7
months in 2019/20 for ensuring external sector stability.
• Helps to achieve the economic growth of around 8.5
percent as targeted by the annual budget of the GoN.
• Open market operations (OMOs) will be conducted by
monitoring the excess liquidity of the BFIs and using
interbank rate of the BFIs as the operating target of the
policy.
• The cash reserve ratio to be maintained by the BFIs has
been kept unchanged at 4 percent.
• The bank rate, applied for the purpose of the lender of the
last resort (LOLR) facility, will be reduced to 6 percent
from 6.5 percent.
• The existing policy provision for the commercial banks to
extend at least 10 percent of their total credit in
agriculture sector and at least 15 percent in energy and
tourism sector has been kept unchanged.
• The existing policy provision for the development banks
and finance companies to extend at least 15 percent and
10 percent of their total credits respectively to the priority
sector has been kept unchanged.
• The policy provision requiring the BFIs to extend at least
5 percent of their total credit to the deprived sector has
been kept unchanged.
• the spread between the average lending and deposit rates
below 4.4 percent by 2020/21.