Published on February 25, 2014
Monetary Policy its constituents and how it helps in growth of economy
MEANING OF MONETARY POLICY Monetary policy is the macroeconomic policy laid down by the central bank (RBI) It involves management of money supply and interest rate and is used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
DESCRIPTION OF MONETARY POLICY OF INDIA • In India, monetary policy of the Reserve Bank of India. • It is aimed at managing the quantity of money in order to meet the requirements of different sectors of the economy. • Also to Increase the pace of economic growth. • Monetary policy can be expansionary and contractionary in nature.
OBJECTIVES OF MONETARY POLICY OF INDIA • Price stability • Controlled expansion of credit • Promotion of fixed investment • Restriction of inventories • Promotion of exports and food procurement operations
Cont. • Desired distribution of credit • Equitable distribution of credit • To promote efficiency • Reducing the rigidity
CONSTITUENTS OF MONETARY POLICY The RBI implements the monetary policy through: •open market operations •bank rate policy •reserve system •credit control policy •moral persuasion •other instruments
USE OF MONETARY POLICIES IN ECONOMY • Using any of these instruments will lead to changes in the interest rate, or the money supply in the economy. • Increasing money supply and reducing interest rates indicate an expansionary policy. • The reverse of this is a contractionary monetary policy. • For liquidity as is it is important for an economy to spur growth.
Cont. • To maintain liquidity, the RBI is dependent on the monetary policy. • By purchasing bonds through open market operations, the RBI introduces money in the system and reduces the interest rate.
F O Y T S LI C N O E U P T I Y T S R N ETA O N C O M
OPEN MARKET OPERATIONS • An open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. • This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit.
Cont. • The RBI sells government securities to contract the flow of credit and buys government securities to increase credit flow. • Open market operation makes bank rate policy effective and maintains stability in government securities market
CRR • Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances . • Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.
SLR • Statutory Liquidity Ratio • Every financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities.
Cont. • These assets can be cash, precious metals, approved securities like bonds etc. • The ratio of the liquid assets to time and demand liabilities is termed as the Statutory liquidity ratio
BANK RATE POLICY The bank rate is also known as the discount rate. • It is the rate of interest charged by the RBI for providing funds or loans to the banking system. • Funds are provided either through lending directly or rediscounting or buying money market instruments like commercial bills and treasury bills
Cont. This banking system involves: • commercial and co-operative banks • Industrial Development Bank of India • IFC (International Finance Corporation) • EXIM Bank • and other approved financial institutes.
CREDIT CEILING • In this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. • In this case commercial bank will be tight in advancing loans to the public. • They will allocate loans to limited sectors.
CREDIT AUTHORIZATION SCHEME • Credit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya was the chairman of RBI. • Under this instrument of credit regulation RBI as per the guideline authorizes the banks to advance loans to desired sectors
MORAL SUASION • Moral Suasion is just as a request by the RBI to the commercial banks to take so and so action and measures in so and so trend of the economy. • RBI may request commercial banks not to give loans for unproductive purpose which does not add to economic growth but increases inflation
REPO RATES • Repo rate is the rate at which RBI lends to commercial banks generally against government securities. • Reduction in Repo rate helps the commercial banks to get money at a cheaper rate • Increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive.
REVERSE REPO RATE • Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. • The increase in the Repo rate will increase the cost of borrowing and lending of the banks • which will discourage the public to borrow money and will encourage them to deposit. • As the rates are high the availability of credit and demand decreases resulting to decrease in inflation.
ROLE OF MONETARY POLICY IN GROWTH OF ECONOMY OPEN MARKET OPERATIONS To correct the situations of inflation in the country the central bank i.e. RESERVE BANK OF INDIA sells the securities of the government in the open market. During the situations of deflation or deficient demand, the RBI buys the securities from the open market.
ROLE OF MONETARY POLICY IN GROWTH OF ECONOMY BANK RATE POLICY During the situation of inflation in economy the bank rates are reduced by the central government. During the deflation or situation of deficient demand in the economy the bank rates are increased by the central government increasing the credit creation by commercial banks.
ROLE OF MONETARY POLICY IN GROWTH OF ECONOMY CASH RESERVE RATIO When the economy suffers inflation the CRR is increased by the central government of the country. On the other hand when the economy suffers deflation the CRR is decreased by the central government.
ROLE OF MONETARY POLICY IN GROWTH OF ECONOMY STATUTORY LIQUIDITY RATIO During the situations of inflation or excess demand he SLR is increased by the central government of the country. When the country id hit by deficient demand or deflation the SLR is decreased by the central government.
ROLE OF MONETARY POLICY IN GROWTH OF ECONOMY MORAL SUASION During inflation in the economy central government put pressure on commercial banks to be selective in lending credits. When there is deflation in the country the central government puts pressure on commercial banks to be liberal in lending to the public.
CURRENT MONETARY POLICY RATES • CRR 4.00% • SLR 23% • BANK RATE 9% • REPO RATE 8.00% • RESERVE REPO RATE 7.00%
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