Unit 15. Tools of Monetary Policy

I. In order to monitor the economy, the central monetary authorities have to use 2 major tools to implement monetary policy, which is to influence the movements of interest rates. The 2 major tools are as followed: a ） General Credit Control ( 总体信贷控制 ) b ） Selective Credit Control ( 选择性信贷控制 )

II. General Credit Control

A. Definition of general credit control: General credit control affects the entire banking and financial system through reserve requirements( 法定储备金要求 ), the discount rate( 贴现率 ) and open market operations( 公开市场操作 ).

B. Reserve Requirements: It was believed that the primary purpose of reserve requirements was to safeguard the public deposits and avoid bank run. (1) reserve requirements reduced a portion of what were required reserve now becomes excess reserves depository institution soon convert all or a portion of these newly created excessive reserves into loans and investment expand money supply lower interest rate lower the borrowing cost of businesses more businesses borrow funds to increase investments stimulate the economy (2) If all institutions are fully loaned up, with zero excess reserves, increase of reserve requirements some depository institutions will be short of required legal reserves these institutions will be forced to sell securities, cut back on loans or borrow reserves from other financial institutions to meet the reserve requirements decrease money supply increase interest rate increase the borrowing costs of businesses less businesses borrow funds to increase investments slow down the economy

C. Discount rate is the annual percentage interests charged on those institutions choosing to borrow from the Fed’s discount window. (1) increase discount rate borrow from the Fed is more costly than to use some other sources of funds increase the borrowing costs of commercial banks decrease money supply to the overall economy to stir the economy (2) decrease discount rate borrow from the fed is less costly than to use some other sources of funds decrease the borrowing costs of commercial banks increase money supply to the overall economy to slow down the economy

D. Open Market Operation Open market operations consist of buying and selling US government securities by the Fed to affect the money supply, ultimately general credit conditions. It is the most flexible policy tool available to the Fed, suitable for fine-tuning the financial markets when this is necessary. (1) Fed buys securities inflow of the funds to the banking system and expansion of its abilities to make loans and create deposits increase the money supply to stir the economy (2) Fed sells securities outflow of the funds from the banking system and decrease of its abilities to make loans and create deposits decrease the money supply slow down the economy

III. Selective Credit Control

A. Moral suasion ( 道义劝说 ) Moral suasion refers to the use of pressure by central bank to encourage banks and other lending institutions to conform with the spirits of its policies, such as the issuance of letters and public statements to urge banks to restraint in granting loans

B. Margin Requirements ( 保证金要求 ) According to the Securities Exchange Act of 1934, margin requirements were enacted into law. This federal law limits the amount of credit that could be used as collateral for a loan. Fed prescribes a maximum loan value for marginal stocks and convertible bonds. That maximum loan value is expressed as a specified percentage of the market value of the securities at the time they are used as loan collateral. The margin requirement on a regulated security is simply the difference between its market value (100 percent) and the maximum loan value of that security. (Both general credit control and selective credit control are to avoid financial crisis.)