The relevance and importance of a diversified, vibrant and efficient credit structure can hardly be over emphasized in a developing economy. The pattern of credit structure varies from one country to another country depending on a variety of economic, social and political factors. With reference to the mixed economy, the credit structure includes a complex of institutions, both in the organized and unorganized segments of the financial sector.

The prime position in the credit structure of the country is occupied by the central bank of the country. The central bank assumes the role of a regulator of monetary system and policy in the country. It functions not only as a watchdog of the monetary system but also as a promotional and development banker.

The central bank of any country is the sole authority to enforce the monetary cum credit policy of the country. In order to appreciate the role and responsibility of the central bank in an economy, it is necessary to take stock of the objective, instruments and mechanism of monetary policy and its operation in a thorough manner.

The primary objective of the monetary policy is to maintain the domestic price stability and exchange rate stability. There may also be subsidiary objectives like promotion of social justice, expansion of growth etc.

The central bank can operate in the following set of instruments which affect the money and credit supply to the economy.

Quantitative credit control:

Bank rate operations;
Open market operations;
Reserve ratio variations etc.

Qualitative credit control:

Margin requirement;
Moral suasion;

Seasonwise commodity policy;

Consumers credit etc.

The purpose of quantitative or general credit control weapons is to affect the total volume of money and credit, whereas the purpose of qualitative or selective credit control weapons is to affect the availability of credit. For example, the central bank can raise the bank rate or can sell government securities or can raise the variable reserve ratio. All these go under the term; “dear money policy” or “contractionary money policy” in order to control inflation by way of demand management. In the same way, the central bank can reduce the bank rate, or buy securities or reduce the reserve ratio. All these mean “cheap money policy” or expansionary money policy for the purpose of promoting investment and overcome business recession. In the same manner, qualitative weapons are operated to control speculative activities with regard to sensitive items.

There is a theoretical debate concerning the mechanism and efficacy of monetary policy operations. The debate is between the Keynesians and the monetarist. It is argued by the Keynesians that it is futile to operate on monetary policy, if there is liquidity trap because an easy money policy cannot effect interest, investment and hence income. On the other hand, the monetarists argue that by controlling money supply, one can control investment, income as well as price level. A ten percent reduction in money supply can reduce price level by exactly 10 percent. This is known as the quantity theory approach and there are many assumptions behind such an approach. Such assumption may not always obtain in reality and it can make monetary policy ineffective. The so called money multiplier may not work if the money and capital market is not organized and developed.

Source by Benny