What are the main tools of monetary policy used by a central bank?

• A. Fiscal policy, budget deficits, and tax policy.
• B. Open market operations, discount rate, and reserve requirements.
• C. Foreign exchange interventions, capital controls, and inflation targeting.
• D. Bank licensing, supervisory oversight, and deposit insurance.

Answer: (B)

The main concept here is identifying the instruments central banks actually use to influence money, credit, and interest rates. The classic set consists of open market operations, the discount rate, and reserve requirements. Open market operations are the buying or selling of government securities to adjust the money supply and steer short-term rates toward the target. The discount rate is the rate banks pay to borrow from the central bank; changing it affects banks’ borrowing costs and lending activity. Reserve requirements set the minimum amount of funds banks must hold in reserve, which directly impacts how much they can lend. Lowering reserves or the discount rate tends to expand money supply and lower rates, while raising them contracts liquidity and pushes rates up.

Fiscal policy—government spending and tax choices—belongs to the realm of fiscal policy, not monetary policy, so it’s not a central-bank tool. Foreign exchange interventions or capital controls can influence policy outcomes in some contexts but are not the routine set of monetary instruments. Inflation targeting describes a framework for guiding policy but is not a direct instrument itself. Bank licensing, supervision, and deposit insurance are regulatory and supervisory tools, not primary monetary policy instruments.