MONETARY POLICY INSTRUMENTS – are the intermediate target variables that in turn THE CASE FOR VANUATU affect the ultimate objectives of economic growth, price stability and viable balance of 1. Introduction payments. One of the main objectives of the Reserve Bank 3. Evolution of Monetary Policy and of Vanuatu is to promote monetary stability. Monetary Policy Instruments in Vanuatu This objective is stated in section 3 of the Reserve Bank of Vanuatu Act. The monetary Monetary Policy Instruments influence the stability objective requires that the Bank has to growth of the money supply which in turn affect ensure the value of the vatu is stable at all times. prices and the level of economic activity. To achieve the objective of monetary or price Determining the appropriate level of money in stability, the Reserve Bank of Vanuatu all its forms is one of the most important formulates and implements monetary policy. responsibilities of the Reserve Bank. An ideal Monetary policy formulation involves position is to have neither too much nor too little developing a plan to achieve the Bank’s money in the country. Therefore the focus of objective of price stability. In implementing the the Bank’s monetary policy is to strike the plan, the Reserve Bank utilizes monetary policy appropriate balance. instruments. The Reserve Bank of Vanuatu has a number of instruments at its disposal to The evolution of monetary policy around the implement monetary policy. This article world has shown that most central banks started describes the various monetary policy with direct monetary policy and then moved on instruments that the Reserve Bank of Vanuatu to adopt indirect monetary policy. This also was uses to implement monetary policy to achieve its the trend in Vanuatu. During the period between ultimate objective of price or monetary stability. 1980 and 1998, monetary policy was described as passive. During 1983, in a bid to develop the 2. What is a monetary policy instrument? productive sector of the economy, the Bank employed direct monetary policy by issuing A monetary policy instrument is a tool that informal directives to commercial banks on the central banks around the world use to implement allocation and cost of credit. Nevertheless, the monetary policy. In Vanuatu, the Reserve Bank controls proved counter productive because of a of Vanuatu, being the country’s central bank, rise in bad loans and were later abandoned. In uses a number of monetary policy instruments. 1988, the Bank introduced reserve requirement The Bank can implement monetary policy in two of 10% for the first time, a first move to indirect ways: directly through the regulatory powers monetary policy. However, in March 1998, that it has, or indirectly through its influence subsequent to the financial crisis involving the over reserve money. Thus, the Bank could use Vanuatu National Provident FUND (VNPF), the direct monetary policy instruments or indirect RBV abolished the SRD of 10% and replaced it monetary policy instruments. Direct instruments with the Prescribed Reserve Assets (PRA) at refer to the one-to-one correspondence between 16%. The PRA was introduced to raise funds the instruments and the objective, for example, for the government to help VNPF pay out its credit ceilings to control the growth of domestic members’ contributions, as well as to manage credit. Actually, direct instruments are aimed at liquidity. Banks were required to hold PRA in the balance sheets of commercial banks. Indirect the form of bonds, treasury bills and RBV monetary policy instruments or market based Notes. In March 1998, Treasury Bills were instruments, on the other hand, are aimed at the issued for the first time. Also, during March the balance sheet of the Reserve Bank, thereby; RBV issued the first Reserve Bank of Vanuatu affects the balance sheet of the banks indirectly. (RBV) Notes to mop up excess liquidity in the The main tools used by the Reserve Bank of system therefore marks the beginning of open Vanuatu to implement monetary policy include market operations (OMO). Reserve Requirements, Open Market Operations, Standing Facilities – Rediscount and In May 1998 the Bank resorted to interest rates Repurchase Agreement and Interest Rates. policy. It increased the minimum lending rate These monetary policy instruments influence the (MLR) by 5 percentage points to 10.97 percent. availability of credit and money supply, which The minimum lending rate is the official interest rate at which the Bank charged commercial end of 1998. In April 1999, the Bank increased banks that borrowed high powered money from the reserve requirement ratio to 10% with half of the Bank. The increase in interest rates was a demand deposits in foreign currency included in signal that the Bank tighten monetary policy, an the calculation base. Following the action that resulted in restored confidence in the reintroduction of SRD in late 1998 and 1999, Vatu. Toward the end of December 1998 the commercial banks now hold only one account Reserve Bank introduced the re-discounting and with the RBV (comprising SRD and Excess repurchase agreement (repos) facilities at 7 reserves). SRD is maintained on a daily average percent. With the introduction of the two new during maintenance period of one month. facilities whereby banks can borrow from the Bank if they are short in liquidity, the minimum b. Open Market Operations lending rate was abolished effective 1st May 1999. Effective 1 May 2001 the repo rate was Open market Operations is a process whereby reduced to 6.50 percent from 7.0 percent. This central banks buy and sell securities in the interest rate serves as the official interest rate of market. Open market operations are used by the the Bank. Reserve Bank as a ‘fine tuning’ instrument compared to reserve requirements, which only 4. The Instruments of Monetary Policy in absorbs liquidity. Open Market Operations is Vanuatu perhaps the most important monetary policy tool currently used by the Reserve Bank of Vanuatu. a) Reserve Requirements/Statutory Reserve In conducting open market operations, the Deposits Reserve Bank of Vanuatu buys and sells its own Reserve requirements are percentage of deposit paper, the Reserve Bank of Vanuatu Notes liabilities that commercial banks must hold as (RBV Notes) in open market operations. It does reserves either as vault cash or deposit with the this to fine tune the level of liquidity in the Reserve Bank. Reserve requirements work to financial system. For example, in periods of remove certain percentages of deposit liabilities high (low) system liquidity the Bank sells (buys) from being available for lending by banks. In RBV Notes. When the Bank sells (buys) RBV other words, reserve requirements absorb Notes it absorbs (injects) liquidity in the system. liquidity from the system and it does this in a more structured manner. Reserve requirements The Bank started to issue RBV Notes in March play two roles in monetary policy; one of which 1998 in response to the massive payouts of is to smooth market interest rates in the short members’ contribution by the Vanuatu National term, and to influence the level of bank credits Provident Fund (VNPF). The original Note had in the longer term. a maturity of 91-days while the 28-days RBV Note was introduced in June 1998. Currently, In Vanuatu, the maintenance of reserve RBV Notes have maturities of 14-days, 28-days, requirements is stipulated under the Reserve 63-days, 91-days and 119-days. The Bank Bank of Vanuatu Act1. All commercial banks in conducts open market operations two times in a Vanuatu are required to maintain 10% of the month and the scale of the operation are based average of vatu deposits and half of demand on the results of a reserve money program. deposits in foreign currency as reserves with the Reserve bank of Vanuatu. Reserve requirement c. Rediscount and Repurchase Agreement was introduced in 1988 mainly for prudential Facilities reasons. When it was introduced, commercial Rediscount and repurchasing agreement banks were required to maintain 10% of their facilities are introduced by the Reserve Bank to vatu deposit liabilities in a blocked account with help commercial banks manage their liquidity. the Reserve Bank. This ratio remained until Commercial banks that are short on liquidity can 1998; following the financial crisis involving the obtain credit from the Reserve Bank through VNPF when it was temporarily abolished and these facilities. The rediscount and repurchase replaced with prescribe reserve assets (PRA). agreement facilities were introduced by the SRD was re-introduced at 6.0 percent toward the Reserve Bank towards the end of 1998. However, prior to the introduction of these two 1 The Reserve Bank of Vanuatu Act CAP 125, Laws facilities, commercial banks have, since 1980, of the Republic of Vanuatu, 1980. been able to source overnight funds from the Reserve Bank through the Bank’s advance facility. Normally, Government bonds are pledged as collateral for the advances and the interest rate charged is equal to the minimum- lending rate. For the rediscount facility banks can sell (rediscount) short-term securities to the Reserve Bank for cash. By discounting the securities (treasury bills and RBV Notes) commercial banks obtain credit from the Bank at lower value than the face value of the security that was discounted. Repurchase agreement is also a collateralized loan. It is an agreement between the seller of the security and the purchaser of the security whereby the seller will repurchase the security at an agreed future date and price. In the event, the purchaser of the security provides cash loan to the seller, which is repaid when the original owner repurchases the security. Therefore, a repurchase agreement is an agreement between two parties (Reserve Bank of Vanuatu and a commercial bank) and it involves cash, a security (bonds or RBV Notes) and two transactions of which one takes place at and agreed future date. The period of the agreement can range from overnight to two weeks. d. Interest Rates The interest rate on advances through the rediscount or repurchasing agreement also serves as the official interest rate or indicator rate for the Bank’s monetary policy stance. Currently, the official interest rate is maintained at 6.5 percent since 1 May 2001 when it was reduced from 7.0 percent. As an indicator rate, it gave a signal to the market about the monetary policy stance of the Bank. For example, an increase in the official interest rate would indicate that the Bank is tightening monetary policy, whereas a decrease in the rate means an easing of monetary policy.
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