Monetary policy is the policy relating to the regulation of supply of money, rate of interest and availability of money, with a view to combat situation of inflationary or deflationary gap in the economy. This policy is taken by the Central Bank of the country.
(i) Bank rate It is the rate at which the Central Bank offers loan to the commercial banks as lender of last resort’. During inflation, bank rate is increased to reduce the money supply in the economy because commercial banks will also increase the interest rates accordingly. It will imply a check on the borrowing from commercial banks. Thus, overall supply of money/credit is reduced in the economy. During deflation, bank rate is lowered leading to increase in supply of money/credit.
(ii) Margin requirements A margin refers to the difference between market value of the security offered for loan and the amount of loan offered by the commercial bank. During inflation, supply of money/credit is reduced by raising the requirement of margin and vice-versa.