Explain monetary policy, its instruments and how it works, with reference to the Central Bank of Sri Lanka.

1. 1 · Define monetary policy. Management of interest rates, money and credit by the central bank.
2. 2 · State the CBSL's objectives and framework. Domestic price stability and financial system stability (Act No. 16 of 2023); flexible inflation targeting.
3. 3 · Explain the instruments.
   • Policy interest rate
   • Open market operations
   • Statutory reserve ratio
   • Standing facilities, direct controls, FX operations
4. 4 · Show the transmission mechanism. [Diagram: flow from policy rate to bank rates, borrowing and spending, AD, output and inflation]
5. 5 · Tight versus easy policy. Tight to fight inflation; easy to support growth; effects on loans, saving and the exchange rate.
6. 6 · Global rate policies. Rate rises by major central banks cause capital outflows and currency pressure in developing economies.
7. 7 · Sri Lankan business link. Policy rate changes pass through to loan rates at commercial banks, changing the cost of business borrowing.
8. 8 · Limits and conclusion. Time lags, weak transmission, liquidity traps and supply shocks limit monetary policy; it works best with supportive fiscal policy.

Scoring tip: Write the transmission chain as arrows. It shows the examiner you understand the mechanism, not just the tools.