Operating Procedures and Instruments
The operating framework relates to all aspects of implementation of monetary policy. It primarily involves three major aspects, namely,
(i) choosing the operating target,
(ii) choosing the intermediate target, and
(iii) choosing the policy instruments.
The operating target refers to the variable (for e.g. inflation) that monetary policy can influence with its actions. The intermediate target (e.g. economic stability) is a variable which the central bank can hope to influence to a reasonable degree through the operating target and which displays a predictable and stable relationship with the goal variables. The monetary policy instruments are the various tools that a central bank can use to influence money market and credit conditions and pursue its monetary policy objectives.
The day-to-day implementation of monetary policy by central banks through various instruments is referred to as ‘operating procedures’. For implementing monetary policy, a central bank can act directly, using its regulatory powers, or indirectly, using its influence on money market conditions as the issuer of reserve money (currency in circulation and deposit balances with the central bank).
In general, the direct instruments comprise of:
(a) the required cash reserve ratios and liquidity reserve ratios prescribed from time to time.
(b) directed credit which takes the form of prescribed targets for allocation of credit to preferred sectors (for e.g. Credit to priority sectors), and
(c) administered interest rates wherein the deposit and lending rates are prescribed by the central bank.
The indirect instruments mainly consist of:
(a) Repos
(b) Open market operations
(c) Standing facilities, and
(d) Market-based discount window.
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