Instruments of Monetary Policy

The Bank of Jamaica's two main operational tools used in the management of the monetary base are open market operations and reserve requirements. Management of the monetary base focuses on the balance sheet of the Bank of Jamaica, in particular its net domestic assets (NDA) and net international reserves (NIR). The Bank's balance sheet is represented by the following identity:

MB = NDA + NIR
Where MB, the monetary base, is the sum of notes and coins issued by the central bank and commercial bank cash reserves.
 

The operational tools, open market operations and reserve requirements are used to influence financial activities of the institutions over which the BOJ has supervisory responsibilities and ultimately the other financial institutions in the system.
Open market operations (OMO) are the most important monetary policy tool and determinant of changes in the monetary base. These changes in turn influence fluctuations in the money supply. This relationship between the money supply and the monetary base is expressed below:
M* = k MB
Where k = the money multipliers and
M* = the money supply

OMO constitute an indirect instrument of monetary policy and involve the issuing of the Bank's own certificates of deposits as well as the purchase or sale of Government securities. These respective agreements are used to influence the level of liquidity in the financial system, the volume of credit and the level of interest rates. In practice, Open market purchases of Government securities from the market or the early encashment of BOJ's certificate of deposits will expand the Bank's monetary base, thereby raising the money supply through the multiplier process. On the other hand, an open market sale contracts the monetary base, lowering the money supply.

   
Reserve Requirements is the only direct policy tool within the operational framework of the Bank. Reserve requirements are the portion of prescribed liabilities that financial institutions have to keep on hand or hold on deposit at the Bank of Jamaica. By law, the Central Bank requires that for every dollar of its prescribed liabilities at the supervised financial institutions, a fraction must be held on deposit at the Bank of Jamaica. Reserves requirements therefore define a limit on the amount of credit that a financial institution can extend. The cash reserve requirement stipulates that a certain proportion of the deposits of the institution are held on deposit at the Bank in the form of cash. Thus, changes in the cash reserve requirements affect the money supply by causing the multiplier to change. A decline in reserve requirements leads to an expansion of the money supply because more multiple deposit creation can take place, while an increase in the reserve requirement reduces the money supply.

The Bank also controls liquidity through its intervention (direct sales/purchases) in the foreign exchange market. The efficient management of the flexible exchange rate system requires that the Bank intervene in the market from time to time to smooth out supply conditions and to ensure relative stability of the exchange rate. Thus, the bank utilizes its monetary policy tools to influence the flow of foreign currency and any pressures emanating in the foreign exchange market.



 

Open market instrument issued by the Bank of Jamaica, which is backed by the Bank's guarantee to repay amounts deposited at the agreed time of maturity.

The requirement by law that a percentage of deposit liabilities of deposit-taking institutions must be held as deposits at the Bank of Jamaica.

Flexible exchange rates are determined by demand and supply conditions in the market.

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