Monetary Policy - Rohit Sharma · 2012-12-07 · yInitially, the RBI used to announce all its...

Monetary Policy

Dr Kavita SrivastavaDr. Kavita Srivastava

Department of Management

ITS Gh b dITS, Ghaziabad

Definition

Monetary policy refers to a programme of action undertaken by the monetary authorities generally the undertaken by the monetary authorities , generally the central bank, to control and regulate the supply of money with the public and the flow of credit with a view to with the public and the flow of credit with a view to achieving predetermined macroeconomic goals

12/23/20092 Dr. Kavita Srivastava

Scope of Monetary Policy

Depends on the level of monetization of the economy

L l f d l t f th it l k tLevel of development of the capital market


Instruments of Monetary policyQuantitative ToolsQuantitative Tools

Bank Rate

O M k t O tiOpen Market Operations

Cash Reserve Ratio or Statutory Reserve Ratio

Statutory Liquidity Requirement: the proportion of total deposits which commercial banks are statutorily required to

i i i h f f li id i h ld maintain in the form of liquid assets i.e., cash reserve, gold and government bonds in addition to CRR. To prevent the commercial banks from liquidating their assets when CRR is commercial banks from liquidating their assets when CRR is raised.


Repo Rate & Reverse Repo RateRepo Rate Repo Rate

Discount rate at which a Central Bank repurchases government securities from the commercial banks government securities from the commercial banks , depending on the level of money supply it decides to maintain in the country’s monetary system.maintain in the country s monetary system.

To temporarily expand the money supply, the central bank decreases repo rate. decreases repo rate.

Reverse repo rate


Reverse Repo RateThe rate at which RBI borrows money from the banks (or banks lend y (money to the RBI) is termed the reverse repo rate.The RBI uses this tool when it feels there is too much money floating in th b ki tthe banking systemIf the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a yresult, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk))Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economyReverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks, while repo signifies the rate at which liquidity is injected.


Call Rate

Call rate is the interest rate paid by the banks for lending and borrowing for daily fund requirement Since banks need borrowing for daily fund requirement. Since banks need funds on a daily basis, they lend to and borrow from other banks according to their daily or short-term requirements on banks according to their daily or short term requirements on a regular basis.


Qualitative ToolsChange in Lending Margins: banks advance loans only up to Change in Lending Margins: banks advance loans only up to certain percentage of the mortgaged property .Gap between value of the mortgage property and amount advanced is va ue o t e o tgage p ope ty a a ou t a va ce s called ‘lending margin’.

Example: if value of stock is Rs. 10 million and amount Example: if value of stock is Rs. 10 million and amount advanced is only Rs 6 million, the lending margin is 40 %.

Credit RationingCredit Rationing

Moral Suasion

Direct ActionDirect Action


Monetary Policy of IndiaHistorically the monetary policy was announced twice aHistorically, the monetary policy was announced twice ayear—a slack-season policy (April–September) and abusy-season policy (October–March) in accordance withy p y ( )agricultural cycles. These cycles also coincide with thehalves of the financial year.Initially, the RBI used to announce all its monetarymeasures twice a year in the monetary and credit policy.The monetary policy has now become dynamic in natureas RBI reserves its right to alter it from time to time,depending on the state of the economy.


Objectives of Monetary Policy

High rate of growth

F ll l tFuller employment

Price stability

Greater equality in the distribution of income and wealth

Healthy balance in balance of payments


The Limitations of Monetary PolicyThe Time Lag refers to time taken in chalking out the policy The Time Lag refers to time taken in chalking out the policy action, its implementation and response time.

Inside time lag is the time lost in identifying the nature of g y gproblem, identifying the sources of problem, assessing the magnitude of problem, choice of appropriate policy action and implementation of policy actions

Outside lags refers to the time taken by the households and firms h l k b h hto react to the policy action taken by the monetary authorities.

If preparatory and operational lags are long , not only the nature d it d f bl h d i th li and magnitude of problem may change rendering the policy

ineffective, but also it may worsen the situation


Problems in ForecastingCreation of policy requires that the magnitude of recession Creation of policy requires that the magnitude of recession or inflation is correctly assessed , as it helps in determining the dose of the medicine.t e ose o t e e c e.

It is ,thus, important to forecast these variables with suitable and reliable forecasting techniques and hence formulation of and reliable forecasting techniques and hence formulation of an appropriate monetary policy has remained an extremely difficult task.


NBFI’S

The proliferation of non-banking financial corporations , industrial development banks mutual saving funds insurance industrial development banks, mutual saving funds, insurance companies, chit funds and so on have reduced the share of commercial banks in the total credit. commercial banks in the total credit.


Underdeveloped money and capital market

Money and capital market are less developed and Money and capital market are less developed and fragmented.


Functions of central bankRBI was set up in 1935RBI was set up in 1935

Function of Central Bank:

It t th t i It acts as the note issue agency

It acts as the bankers bank

It controls credit

It acts as the lender of the last resort

It manages the exchange rate


Functions of Commercial BanksAccepting DepositsAccepting Deposits

Demand Deposits or Current Deposits

Fi d D it Ti D itFixed Deposits or Time Deposits

Saving Banks Deposits

Recurring Deposits


Advancing LoansAdvancing Loans

Overdraft

L b C ti d itLoans by Creating a deposit

Discounting of bills of exchange

Creation of Credit

Transfer of Money


Role of Commercial Banks

P ti f S iPromotion of Savings

Mobilization of Savings

Allocation of funds


Demand for money

Transactions Motive

P ti tiPrecautionary motive

Speculative Motive


Supply of MoneyCentral bank: central bank is empowered to issue currencyCentral bank: central bank is empowered to issue currency

High power money as it is backed by supporting reserves and its value is guaranteed by the government and it is the source its value is guaranteed by the government and it is the source of all other forms of money.

This liability must be backed by an equal value of assets This liability must be backed by an equal value of assets consisting mainly gold and foreign exchange reserves especially in terms of high power foreign currencies.especially in terms of high power foreign currencies.

In practice , however , most countries have adopted a “ minimum reserve system” minimum reserve system .


RBI measures of money supplyRBI has been using since April 1977 the following definition RBI has been using since April 1977 the following definition and measures of money supply:

M1= C+DD+ODM1= C+DD+OD

M2= M1+Saving deposits with post offices

M3 M1+ N i d i i h h i l b kM3=M1+ Net time deposits with the commercial banks

M4= M3 + Total deposits with post offices

Where, C=Currency held by the public , DD = net demand deposits with banks , OD = other deposits with RBI


Thank You


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Monetary Policy - Rohit Sharma · 2012-12-07 · yInitially, the RBI used to announce all its...

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