Downloaded 23 times
Uploaded bySuvin Lal
Monetarypolicy 140220113016-phpapp02
Monetary policy refers to actions undertaken by central banks to regulate money supply and credit conditions to promote economic goals like price stability and growth. The key objectives are ensuring economic stability, achieving price stability, and promoting growth. Tools include open market operations, bank rate/discount rate, cash reserve ratio, and moral suasion. Central banks use these to contract money supply and credit during inflation or expand them during recession by buying/selling government securities and adjusting policy rates and reserve requirements. However, monetary policy faces limitations from time lags in implementation and effects, difficulties in forecasting, and underdeveloped financial markets in some countries.
More Related Content
Similar to Monetarypolicy 140220113016-phpapp02
Monetarypolicy 140220113016-phpapp02
- 1. Economic policies forStabilization Economic Policy Fiscal Policy Monetary Policy
- 2.
- 3. Meaning “A programme ofaction undertaken by the monetary authorities – The Central Bank to control and regulate the supply of money with the public and flow of credit with the view of achieving macroeconomic goals.” Or “ The Monetary and Credit Policy is the policy statement, traditionally announced twice a year, through which the Reserve Bank of India seeks to ensure price stability for the economy.”
- 4. Objective 1) To ensureEconomic Stability (Exchange Rate &Financial Market). 2) To achieve Price Stability by Controlling Inflation and Deflation. 3) To promote and encourage Economic Growth in the Economy.
- 5. Instruments / Tools Toolsof Monetary Policy Quantitative / Traditional Measures Qualitative / Selective Measures
- 6. Quantitative Measures Quantitative Measures Open Market Operations(OMO) Discount Rate / Bank Rate Cash Reserve Ratio (CRR) Others…
- 7. 1) Open MarketOperations ( OMO) RBI sells or buys government securities in open market depend upon - it wants to increase the liquidity or reduce it. RBI sells government securities It reduces liquidity (stock of money) in the economy. So overall it reduces the money supply available with banks, Reduces the capital available for lending and interest rate goes up. RBI buys securities Increases the money supply available with banks, so interest rate moves down and business activities like new investments, capacity expansion goes up.
- 8. The saleof govt bonds and securities effect both demand and supply of credit. Supply of Credit The Govt bonds are bought by cheques drawn on the commercial bank in favour of the central bank. So money gets transferred from the buyers account to central bank account. So this reduces total deposits with the commercial bank and their cash reserve and also their cash creation capacity. When Commercial Bank buys, their cash reserve goes down leads to fall in flow of credit. Demand for Credit Selling of Bonds by Central Bank, Interest rate goes up. Reduces demand for credit
- 9. Limitations of OMO If Commercial bank possess excess liquidity then OMO are not effective. Popularity of Govt bonds and securities maters. They are not so popular as they have a low rate of return. In Underdeveloped countries where Banking system are not well developed and integrated they have limited effectiveness. In a unstable market economy OMO is not effective due to lack of demand for credit.
- 10. 2) Discount Rate/ Bank Rate ( 6%) Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate. or Is the interest rate charged on borrowings ( Loans and Advances) made by the commercial bank from the central bank. Central Bank can change this rate – depending upon Expansion or Contraction of credit flow. A fall in Bank Rate- Expansionary Monetary Policy A rise in Bank Rate – Contractionary Monetary Policy
- 11. The action ofthe Central Bank effects the flow of credit : 1) Rise or fall in rate of Central Bank raises its rate leads to rate change of commercial bank. So demand for funds by borrowers get effected. 2) Bankers lending rates get adjusted to deposit rates. Rise in deposit rate turns borrowers into depositors. 3) Rise in in Bank rate reduces the net worth of Govt Bonds against which commercial banks borrow funds from the central bank. They find it difficult to maintain high cash reserve.
- 12. Limitations of BankRate policy It can work effectively when: 1) When Commercial Bank approach the Central Bank for borrowings. 2) The Commercial Bank are more dependent upon Capital Market. Share of banking credit ahs declined 3) Changes in Bank Rate must influence interest rates. But these days Commercial Bank hold on to their interest rate than get affected by Bank Rate.
- 13. 3) Cash ReserveRatio (CRR) ( 5.75% ) All commercial banks are required to keep a certain amount of its deposits in cash with RBI. This percentage is called the Cash Reserve Ratio. To prevent shortage of cash To control Money supply In Contractionary policy the bank raises the CRR In Expansionary policy bank reduces the CRR A hike in CRR will lead to high interest rate, credit rationing, huge decline in investment and large reduction in National Income and Employment
- 14. For Ex CRR= 20% Total Deposit = 100 million Loan= 80 Million Deposit Multiplier = 1/ CRR = 5 Additional Credit = 400 Million CRR = 25% Total Deposit = 100 million Loan = 75 Million Deposit Multiplier = 1/ CRR = 1/25 % = 4 Additional Credit = 300 million
- 15. Other Methods……. 1) StatutoryLiquidity Requirement ( SLR) ( 24% ) Another kind of reserve, in addition to CRR. It’s the proportion of the total deposits which commercial banks are required to maintain with the central bank in the form of liquid assets - Cash reserve, Gold, Government Bonds This measure was undertaken to prevent the commercial bank to liquidate their liquid assets when CRR is raised.
- 16. 2) Reporate (4.75%) Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which our banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive. The repo rate transactions are for very short duration It denotes injection of liquidity.
- 17. 3) Reverse Reporate( 3.25%) A reverse repo rate is the interest rate earned by a bank for lending money to the RBI in exchange for Government securities. Reverse repo is an arrangement where RBI sells the securities to the bank for a short term on a specified date. RBI us his tool when there is to much liquidity in the banking system. Reverse reporate means absorption of liquidity. They give money to depositors at 4% and turn around and lend that money to others that want to buy a home or expand their business at 6-8% or higher depending on the risk.If they lend more money than they take in on a given day they may have to borrow money from the fed on a short term basis which would be the bank rate.
- 18. Qualitative Measures Qualitative Measures Credit Rationing Changein Lending Margin Moral Suasion Direct Control
- 19. 1) Credit Rationing Shortage of funds, priority and weaker industries get starved of necessary funds. Central Bank does credit rationing Imposition of upper limits on the credit available to large industries. Charging higher interest rate on bank loans beyond a limit 2) Change in Lending Margins Bank provides loans upto a certain percentage of value of mortgaged property. The gap between the value of the mortgaged property and amount advanced is called as lending margin. Central Bank has the authority to determine the lending margin with the view to decrease and increase the bank credit The objective is to control speculative activity in the stock market.
- 20. 3) Moral Suasion It’s a Psychological instrument instrument of monetary policy Persuading and convincing the commercial bank to advance credit in accordance with directive of the central bank. The Central bank uses moral pressure on the commercial bank by going public on the unhealthy banking practices. 4) Direct Controls Where all the methods become ineffective Central bank gives clear directives to banks to carry out their lending activity in a specified manner.
- 21. Monetary Policy toControl Recession Problem: Recession Measures: 1) Central Banks buy securities through OMO 2) Lowers Bank Rate 3) Reduces CRR Money Supply Increases Interest Rate Falls Investment Increases Aggregate Demand Increases Aggregate Output increases
- 22. Monetary Policy toControl Inflation Problem: Inflation Measures: 1) Central Banks sells securities through OMO 2) Increases Bank Rate 3) Raises CRR Money Supply Decreases Interest Rate Rises Investment Declines Aggregate Demand Declines Price Level Falls
- 23. Limitations Of MonetaryPolicy 1) Time Lags Time taken in – Implementation and working ‘Inside lag’ or preparatory time ‘Outside lag’ or response time If the time lag are long, the policy may become ineffective The response time lag of monetary policy are longer than fiscal policy 2) Problem In forecasting Its important to forecast the effect of monetary actions However prediction of the outcome and formulation of the policy is a difficult task 3) Non- Banking Financial Intermediaries Huge share in financial operation reduces the effectiveness of monetary policy 4) Underdevelopment of Money and Capital Market Markets are fragmented, unorganised and does work independently