monetary policy

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Information about monetary policy

Published on January 20, 2010

Author: vashishtha.bk


Monetary policy : Monetary policy By B.K.VASHISHTHA MONETARY POLICY : MONETARY POLICY Monetary policy refers to the credit control measures adopted by the central bank of a country to influence the level of aggregate demand for goods and services or to influence the trends in certain sectors of the economy. Monetary policy operates through varying the cost availability of credit. There variations affect the demand for . And the supply of credit in the economy, and the nature of economic activities. OBJECTIVE OR GOALS OF MONETARY POLICY : OBJECTIVE OR GOALS OF MONETARY POLICY Full Employment:- one of the objectives of monetary policy is attain full employment. It is not only because unemployment leads to wastage of potential output. But also because of the loss of social standing and self- respect. It also breeds poverty. Contd…… : Contd…… Price stability :- Another objective of monetary policy is to stabilize the price level. Both , rising and falling prices are bad as the bring unnecessary loss to some and undue advantage to others. They are associated with business cycles. So a policy of price stability keeps the value of money stable, eliminates cyclical fluctuations. Brings economic stability, helps in reducing inequalities of income and wealth, secures social justice and promotes economic welfare Contd… : Contd… Economic growth :-monetary policy can be imposed to influence the rapid economic growth. Economic growth is defined as “the process whereby the real per capita income of a country increases over a long period of time “it is measured by the increase in the amount of goods and services produced in a country. A growing economy produces more goods and services in each successive time period. Thus, growth occurs when an economy’s thus, economic growth implies raising the standard of living of the people, and reducing inequalities of inequalities of income distribution. Contd….. : Contd….. Balance of payments:- another objective of monetary policy since the 1950s has been to maintain equilibrium in the balance of payments. It is also recognized that deficit in the balance of payments will retard the attainment of other objectives. This is because a deficit in the balance of payment leads to a sizeable outflow of gold, Role of monetary policy in a developing economy : Role of monetary policy in a developing economy Monetary policy plays an important role in increasing the growth rate of the economy by influencing the cost and availability of credit by controlling inflation and maintaining equilibrium in the balance of payments. To control inflationary pressures : To control inflationary pressures To control inflationary pressures, monetary policy requires the use of both quantitative and qualitative methods of credit control. The open market operations are not successful in controlling inflation in underdeveloped countries as the bill market is small and undeveloped. Contd….. : Contd….. The use of variable reserve ratio is more effective than open market operations and bank rate policy in LDCs. Since the market for securities is very small, open market operations are not successful. but a rise or fall in the variable reserve ratio by the central bank reduces or increases the cash available with the commercial banks without affecting adversely the prices of securities. To achieve price stability : To achieve price stability Monetary policy is important for achieving price stability. It brings a proper adjustment between the demand for and supply of money. An imbalance between the two will be reflected in the price level. A shortage of money supply will hamper the growth while an excess will lead to inflation. As the economy develops the demand for money increases due to the gradual monetization of the non-monetized sector, and the increase in agricultural and industrial production. This will increase the demand for transactions and speculative motives. So the money supply will have to be raised more than proportionate to the demand for money, to avoid inflation. To bridge BOP deficit : To bridge BOP deficit Interest rate policy plays an important role in bridging the BOP deficit. Underdeveloped countries develop serious balance of payments. To establish infrastructure like power, irrigation, transport etc… and directly productive activities like iron and steel, chemical, electricals, fertilizers , etc, underdeveloped countries have to import capital equipment, machinery, raw materials, spares and components thereby raising their imports, Interest rate policy : Interest rate policy High interest rate in an underdeveloped country acts as an incentive to higher savings develops banking habits and speeds up the monetization of the economy which are essential for capital formation and economic growth. a high interest rate policy is anti inflationary in nature, for it discourages borrowing and investment for speculative purpose, and in foreign currencies To create banking and financial institution : To create banking and financial institution One of the monetary policies in an underdeveloped country is to create and develop banking and financial institution to mobilize and channelize saving for capital formation. establishment of branch banking in rural areas and urban areas should be encouraged. It will help in monetizing the non-monetised sector and encourage saving and investment for capital formation. Debt management : Debt management It is one of the important function of monetary policy in an under developed country it aims at proper timing and issuing of government bonds, stabilizing their prices and minimizing the cost of servicing the public debt. The primary aim of debt management is to create conditions in which public borrowing can increase from year to year borrowing is essential in order to finance development program and to control the money supply. INDIAN FINANCIAL SYSTEM : INDIAN FINANCIAL SYSTEM A financial system should be distinguished from a payments system. it can be defined as the set of institutional arrangements through which purchasing power is transferred from one transaction in exchange to another, Function of the indian financial system: promotion of capital formation : Function of the indian financial system: promotion of capital formation The Indian financial system performs a crucial role in economic development of India through saving-investment process, also known as capital formation. It is for this reason that financial system is sometimes called the financial market. The purpose of the financial market is to mobilize effectively and allocate the same efficiently among the ultimate users of funds viz investors. Contd… The process of capital formation depends upon : Contd… The process of capital formation depends upon Increased in savings, that is , the resource that would have been normally used for consumption purposes, can be released for other development puposes Mobilization of saveing Investment proper, which is the production of capital goods. The composition of indian money market : The composition of indian money market Definition :- according to G. Crowther “it is the collective name given to the various firms and institutions that deal in the various grades of near money” The indian money market is the market in which short term funds are borrowed and lend. Structure of the indian money market : Structure of the indian money market Sub markets in the indian money market : Sub markets in the indian money market Call money market:- the indian money market market is not a single homogenous market but it is composed of several sub markets, each one of which deals in particular types of short term credit. One important sun- market of the indian money market is the call money market, which is the market for very short term funds, also known as money at call and short notice. This market has actually two segments viz….the call market ovemight market and short notice market. Contd‘……. : Contd‘……. b) Bill market in india:- The bill market or the discount market is the most important part of the money market where short term bills-normally up to 90 days-ate bought and sold. The bill market is further sub divided into commercial bill market and treasury bill market. The market for commercial bill has not become very popular in india, unlike the London money market where commercial bill are extensively bought and sold i.e discounted. Contd…. : Contd…. c) Acceptance market: The market for the acceptance of trade bills. The main operators in this market are the acceptance houses and the commercial banks d) Collateral loan market: it is the importance section of the money market. It takes the form of loans over drafts, cash credit. The loan and advance are covered by collaborates like government securities, gold silver stocks of corporation, merchandise etc. Components of money market : Components of money market The various institutions in the money market generally includes the following . Central bank : it is naturally to be the leader of all banks. It is the bank, which is entrusted with the task of controlling the issue of money and funds to the market and regulates credit facilities provided by various other institution. Contd… : Contd… 2. Commercial banks: They play a vital role in the money market. They make advances, discount bills and lend against the promissory notes and the like. They also take help of the market in solving their liquidity problems. Contd…. : Contd…. 3.Discount houses:-discount houses are special institutions for rediscounting the bills of exchange. They usually dealt in three kinds of bills The domestic bills The foreign bills and The government treasury bill Acceptance House Contd..... : Contd..... 4. Acceptance house:- Acceptance house are institutions which specialize in accepting bills of exchange. Generally they are merchant banker. They act as second signatories on the bills of exchange. That is they guarantee the bills of a trader whose financial standing is not known, for making the bill negotiable. CONTD…… : CONTD…… 5. Bill brokers:-The bill brokers intimately know their customers and act as intermediaries between the sellers and buyers of bill for a small commission .sometimes , these bill brokers discount bills on their own account. Stock exchange : Stock exchange It is also known as secondary market. It is the market where existing securities are traded. An association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities.- securities contract act 1956 Functions : Functions Ready market Evaluation of securities Protection of investor Mobilization of saving Capital formation Economic barometer Regulation of company management Clearing house of information Stock exchanges in India : Stock exchanges in India 23 stock exchanges in the country recognized under securities contract act 1956 21 are regional ones and 2 are national stock exchange (NSE) and over the counter exchange of India (OTCEI) National stock exchange (NSE) : National stock exchange (NSE) SET UP IN 1993 WITH IDBI AS THE NODAL AGENCY It operates in two different segment 1.wholesale debt market and 2. capital market. The first concerned with trading in instrument like govt. securities, PSU bonds, CDs, CPs by corporate entities like banks etc. the second is concerned with equity and corporate debt instruments by corporate and individuals. Over the counter exchange of India (OTCEI) : Over the counter exchange of India (OTCEI) OTCEI with the headquarter in Mumbai has started its operation in September 1992. it is jointly promoted by UTI, IDBI, IFCI, LIC, GIC, CANBANK FINANCIAL SERVICES LTD. etc. It is for unlisted companies.

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