MONETARY POLICY
Presented by
WIPINSON W
Presentation Scheme
• Introduction
• Definition and Scope
• Objectives
• Instruments of Monetary Policy
- Quantitative Measures
- Qualitative Measures
• Limitations
• Policy Measures
Introduction
• Widely used tools of economic control and regulations.
• Major aspects;
- meaning and scope.
- instruments and target variables.
- role – in achieving macroeconomic goals.
- effectiveness and limitations.
Definition and Scope
• Monetary policy is the process by which the monetary authority
of a country controls the supply of money, often targeting a rate
of interest for the purpose of promoting economic growth and
stability.
• - Generally Central bank – to achieve macroeconomic goals.
• Depends by and large on two factors.
- the level of monetized economy.
- development of the capital market.
Cont…
• - Encompasses the entire economic activities .
• - economic transactions – carried out – with money – as medium.
• - works by changing the general price level.
• -- Change in the supply of money affects the level of economic
activities through price level – other instruments of monetary
control(BR and CRR) work through capital market.
• Developed capital market – features:
- large number of financially strong commercial banks, fin
institutions, credit org, and short- term bill market.
Cont…
• - a major part of financial transactions are routed through the
capital markets.
• - the commodity sector is highly sensitive to the changes in the
capital market.
• Therefore , it is necessary that capital submarkets have strong
financial links with the commercial banks.
Objectives
• Growth
• Employment
• stability of price and foreign exchange
• BOP equilibrium.
Instruments of Monetary Policy
Classified under two categories:
• Quantitative measures • Qualitative or Selective
or the Traditional credit controls
measures of Monetary
control.
Quantitative Measures
• They are :
1) Open Market Operations.
2) Discount Rate or Bank Rate.
3) Cash Reserve Ratio (CRR).
- SLR
1) Open Market Operations
• Purchase and sale of eligible securities by the central bank.
• At inflation and boom , the central bank sells securities in the
open market and withdraws the surplus money from circulation.
• The central bank buys securities and injects additional money
into circulation during deflation and depression.
2) Discount Rate / Bank Rate
• It is the rate at which the central bank rediscounts first class bills.
• During the period of inflation central bank raises bank rate.
- followed by rise in the interest rate;
- will discourage borrowings and encourage savings.
• During the period of deflation and depression the central bank
lowers the bank rate.
- consequent fall in the interest rate encourages borrowings.
3) Cash Reserve Ratio (CRR)
• Every commercial bank is required to keep with central bank a
certain percentage of its deposits. – reserve ratio.
• When reserve ratio is raised, the commercial banks are forced to
send more cash to the central bank – cash resources of
Commercial banks.
- less
- and lending capacity automatically reduced.
• When RR is lowered
- the cash resources of banks increase
- and they lend more
Cont…
Statutory Liquidity Ratio
SLR- Commercial Banks has to keep a portion of total deposits
with itself in liquid assets.
The objectives of SLR are:
• To restrict the expansion of bank credit.
• To augment the investment of the banks in Government
securities.
• To ensure solvency of banks. A reduction of SLR rates looks
eminent to support the credit growth in India.
Cont…
Value and Formula
• The quantum is specified as some percentage of the total demand
and time liabilities ( i.e. the liabilities of the bank which are
payable on demand anytime, and those liabilities which are
accruing in one months time due to maturity) of a bank.
• SLR Rate = Total Demand/Time Liabilities x 100%
Qualitative or Selective Credit Controls
• RBI generally uses 3 kinds of selective controls on credits:
a) Minimum margins for lending against specific securities.
b) Ceiling on the amounts of credit for certain purposes.
c) Discriminatory rate of interest charged on certain types of
advances.
Limitations of Monetary Policy
1) The time lag. – i.e., time taken in chalking out the policy action,
its implementation and working time.
2) Problem in forecasting . – what is more important is to forecast
the effects of monetary actions.
3) Non – banking Financial Intermediaries.
4) Underdevelopment of money and capital markets.
- effectiveness of monetary policy in less developed countries is
reduced considerably because of the underdeveloped character
of their money and capital markets.
Policy Measures
• As on 16th Dec. 2010, D. Subbarao, Governor, Reserve Bank of
India, stated that the Reserve Bank of India has decide to Retain
the repo rate at 6.25 per cent and the reverse repo rate at 5.25 per
cent under the Reserve Bank’s liquidity adjustment facility (LAF).
• It plans to retain the cash reserve ratio (CRR) at 6.0 per cent of net
demand and time liabilities (NDTL) of scheduled banks.
Cont…
• With regard to liquidity measures, the RBI has decided to, first,
reduce the statutory liquidity ratio (SLR) of scheduled
commercial banks (SCBs) from 25 per cent of their NDTL to 24
per cent with effect from December 18, 2010 and secondly, to
conduct open market operation (OMO) auctions for purchase of
government securities for an aggregate amount of `48,000 crore
in the next one month.
• As on January 21st 2011, the rate of inflation has eased from 16%
to15.52%
CONCLUSION
-fundamentals remain strong and its financial sector is robust.
- monetary policy is flexible and has sufficient instruments at its
disposal.
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