Monetary policy and its constituents

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Monetary Monetary Policy Policy its its constituents and how it constituents and how it helps in growth of helps in growth of economy economy

Transcript of Monetary policy and its constituents

Page 1: Monetary policy and its constituents

Monetary Monetary PolicyPolicy its constituents its constituents and how it helps in growth and how it helps in growth

of economyof economy

Page 2: Monetary policy and its constituents

MEANING OF MONETARY MEANING OF MONETARY POLICY POLICY

Monetary policy is the Monetary policy is the macroeconomic policy laid down by macroeconomic policy laid down by

the central bank (RBI)the central bank (RBI) It involves management of money It involves management of money supply and interest rate and is used supply and interest rate and is used by the government of a country to by the government of a country to achieve macroeconomic objectives achieve macroeconomic objectives like inflation, consumption, growth like inflation, consumption, growth

and liquidity.and liquidity.

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DESCRIPTION OF DESCRIPTION OF MONETARY POLICY OF MONETARY POLICY OF

INDIAINDIA• In India, monetary policy of the Reserve In India, monetary policy of the Reserve

Bank of India.Bank of India.• It is aimed at managing the quantity of It is aimed at managing the quantity of

money in order to meet the requirements money in order to meet the requirements of different sectors of the economy.of different sectors of the economy.

• Also to Increase the pace of economic Also to Increase the pace of economic growth.growth.

• Monetary policy can be expansionary and Monetary policy can be expansionary and contractionary in nature.contractionary in nature.

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OBJECTIVES OF MONETARY OBJECTIVES OF MONETARY POLICY OF INDIAPOLICY OF INDIA

• Price stabilityPrice stability

• Controlled expansion of creditControlled expansion of credit

• Promotion of fixed investmentPromotion of fixed investment

• Restriction of inventoriesRestriction of inventories

• Promotion of exports and food procurement Promotion of exports and food procurement operationsoperations

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Cont.

• Desired distribution of creditDesired distribution of credit

• Equitable distribution of creditEquitable distribution of credit

• To promote efficiencyTo promote efficiency

• Reducing the rigidityReducing the rigidity

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CONSTITUENTS OF MONETARY CONSTITUENTS OF MONETARY POLICYPOLICY

The RBI implements the monetary policyThe RBI implements the monetary policy through: through: •open market operationsopen market operations•bank rate policybank rate policy•reserve systemreserve system•credit control policy credit control policy •moral persuasion moral persuasion •other instrumentsother instruments

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USE OF MONETARY POLICIES IN USE OF MONETARY POLICIES IN ECONOMYECONOMY

• Using any of these instruments will lead Using any of these instruments will lead to changes in the interest rate, or the to changes in the interest rate, or the money supply in the economy. money supply in the economy.

• Increasing money supply and reducing Increasing money supply and reducing interest rates indicate an expansionary interest rates indicate an expansionary policy. policy.

• The reverse of this is a contractionary The reverse of this is a contractionary monetary policy.monetary policy.

• For liquidity as is it is important for an For liquidity as is it is important for an economy to spur growth. economy to spur growth.

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Cont.Cont.

• To maintain liquidity, the RBI is To maintain liquidity, the RBI is dependent on the monetary policy. dependent on the monetary policy.

• By purchasing bonds through open By purchasing bonds through open market operations, the RBI market operations, the RBI introduces money in the system and introduces money in the system and reduces the interest rate.reduces the interest rate.

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CONSTITUENTS OF

CONSTITUENTS OF

MONETARY POLICY

MONETARY POLICY

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OPEN MARKET OPEN MARKET OPERATIONSOPERATIONS

• An open market operation is an An open market operation is an instrument of monetary policy which instrument of monetary policy which involves buying or selling of government involves buying or selling of government securities from or to the public and banks. securities from or to the public and banks.

• This mechanism influences the reserve This mechanism influences the reserve position of the banks, yield on position of the banks, yield on government securities and cost of bank government securities and cost of bank credit. credit.

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Cont.

• The RBI sells government securities to The RBI sells government securities to contract the flow of credit and buys contract the flow of credit and buys government securities to increase credit government securities to increase credit flow. flow.

• Open market operation makes bank rate Open market operation makes bank rate policy effective and maintains stability in policy effective and maintains stability in government securities marketgovernment securities market

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CRRCRR• Cash Reserve Ratio is a certain Cash Reserve Ratio is a certain

percentage of bank deposits which percentage of bank deposits which banks are required to keep with RBI in banks are required to keep with RBI in the form of reserves or balances .the form of reserves or balances .

• Higher the CRR with the RBI lower will Higher the CRR with the RBI lower will be the liquidity in the system and vice-be the liquidity in the system and vice-versa.versa.

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SLRSLR• Statutory Liquidity RatioStatutory Liquidity Ratio

• Every financial institution has to Every financial institution has to maintain a certain quantity of liquid maintain a certain quantity of liquid assets with themselves at any point assets with themselves at any point of time of their total time and of time of their total time and demand liabilities. demand liabilities.

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Cont.Cont.

• These assets can be cash, precious These assets can be cash, precious metals, approved securities like metals, approved securities like bonds etc. bonds etc.

• The ratio of the liquid assets to time The ratio of the liquid assets to time and demand liabilities is termed as and demand liabilities is termed as the Statutory liquidity ratiothe Statutory liquidity ratio

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BANK RATE POLICYBANK RATE POLICYThe bank rate is also known as the The bank rate is also known as the discount rate.discount rate.• It is the rate of interest charged by It is the rate of interest charged by the RBI for providing funds or loans to the RBI for providing funds or loans to the banking system.the banking system.• Funds are provided either through Funds are provided either through lending directly or rediscounting or lending directly or rediscounting or buying money market instruments like buying money market instruments like commercial bills and treasury billscommercial bills and treasury bills

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Cont.This banking system involves:This banking system involves:

• commercial and co-operative bankscommercial and co-operative banks• Industrial Development Bank of IndiaIndustrial Development Bank of India• IFC (International Finance Corporation)IFC (International Finance Corporation)• EXIM BankEXIM Bank• and other approved financial institutes. and other approved financial institutes.

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CREDIT CEILINGCREDIT CEILING• In this operation RBI issues prior In this operation RBI issues prior

information or direction that loans to the information or direction that loans to the commercial banks will be given up to a commercial banks will be given up to a certain limit.certain limit.

• In this case commercial bank will be tight In this case commercial bank will be tight in advancing loans to the public. in advancing loans to the public.

• They will allocate loans to limited sectors.They will allocate loans to limited sectors.

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CREDIT AUTHORIZATION CREDIT AUTHORIZATION SCHEMESCHEME

• Credit Authorization Scheme was Credit Authorization Scheme was introduced in November, 1965 when P C introduced in November, 1965 when P C Bhattacharya was the chairman of RBI.Bhattacharya was the chairman of RBI.

• Under this instrument of credit Under this instrument of credit regulation RBI as per the guideline regulation RBI as per the guideline authorizes the banks to advance loans authorizes the banks to advance loans to desired sectorsto desired sectors

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MORAL SUASIONMORAL SUASION• Moral Suasion is just as a request by the RBI Moral Suasion is just as a request by the RBI

to the commercial banks to take so and so to the commercial banks to take so and so action and measures in so and so trend of action and measures in so and so trend of the economy. the economy.

• RBI may request commercial banks not to RBI may request commercial banks not to give loans for unproductive purpose which give loans for unproductive purpose which does not add to economic growth but does not add to economic growth but increases inflationincreases inflation

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REPO RATESREPO RATES• Repo rate is the rate at which RBI lends Repo rate is the rate at which RBI lends

to commercial banks generally against to commercial banks generally against government securities.government securities.

• Reduction in Repo rate helps the Reduction in Repo rate helps the commercial banks to get money at a commercial banks to get money at a cheaper rate cheaper rate

• Increase in Repo rate discourages the Increase in Repo rate discourages the commercial banks to get money as the commercial banks to get money as the rate increases and becomes expensive.rate increases and becomes expensive.

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REVERSE REPO RATE• Reverse Repo rate is the rate at which RBI Reverse Repo rate is the rate at which RBI

borrows money from the commercial banks.borrows money from the commercial banks.• The increase in the Repo rate will increase The increase in the Repo rate will increase

the cost of borrowing and lending of the the cost of borrowing and lending of the banks banks

• which will discourage the public to borrow which will discourage the public to borrow money and will encourage them to deposit.money and will encourage them to deposit.

• As the rates are high the availability of As the rates are high the availability of credit and demand decreases resulting to credit and demand decreases resulting to decrease in inflation.decrease in inflation.

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ROLE OF MONETARY POLICY IN ROLE OF MONETARY POLICY IN GROWTH OF ECONOMYGROWTH OF ECONOMY

OPEN MARKET OPERATIONSOPEN MARKET OPERATIONS To correct the situations of inflation in the To correct the situations of inflation in the country the central bank i.e. RESERVE BANK country the central bank i.e. RESERVE BANK OF INDIA sells the securities of the OF INDIA sells the securities of the government in the open market.government in the open market. During the situations of deflation or deficient During the situations of deflation or deficient demand, the RBI buys the securities from the demand, the RBI buys the securities from the open market. open market.

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ROLE OF MONETARY POLICY IN ROLE OF MONETARY POLICY IN GROWTH OF ECONOMYGROWTH OF ECONOMY

BANK RATE POLICYBANK RATE POLICY

During the situation of inflation in economy the During the situation of inflation in economy the bank rates are reduced by the central government.bank rates are reduced by the central government.

During the deflation or situation of deficient During the deflation or situation of deficient demand in the economy the bank rates are demand in the economy the bank rates are increased by the central government increasing increased by the central government increasing the credit creation by commercial banks.the credit creation by commercial banks.

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ROLE OF MONETARY POLICY IN ROLE OF MONETARY POLICY IN GROWTH OF ECONOMYGROWTH OF ECONOMY

CASH RESERVE RATIOCASH RESERVE RATIO

When the economy suffers inflation the When the economy suffers inflation the CRR is increased by the central CRR is increased by the central government of the country.government of the country.

On the other hand when the economy On the other hand when the economy suffers deflation the CRR is decreased by suffers deflation the CRR is decreased by the central government.the central government.

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ROLE OF MONETARY POLICY IN ROLE OF MONETARY POLICY IN GROWTH OF ECONOMYGROWTH OF ECONOMY

STATUTORY LIQUIDITY RATIOSTATUTORY LIQUIDITY RATIO

During the situations of inflation or During the situations of inflation or excess demand he SLR is increased by excess demand he SLR is increased by the central government of the country.the central government of the country.

When the country id hit by deficient When the country id hit by deficient demand or deflation the SLR is decreased demand or deflation the SLR is decreased by the central government.by the central government.

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ROLE OF MONETARY POLICY IN ROLE OF MONETARY POLICY IN GROWTH OF ECONOMYGROWTH OF ECONOMY

MORAL SUASIONMORAL SUASION

During inflation in the economy central During inflation in the economy central government put pressure on commercial government put pressure on commercial banks to be selective in lending credits.banks to be selective in lending credits.

When there is deflation in the country the When there is deflation in the country the central government puts pressure on central government puts pressure on commercial banks to be liberal in lending to commercial banks to be liberal in lending to the public.the public.

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CURRENT MONETARY POLICY CURRENT MONETARY POLICY RATESRATES

• CRR 4.00%CRR 4.00%

• SLR 23%SLR 23%

• BANK RATE 9%BANK RATE 9%

• REPO RATE 8.00%REPO RATE 8.00%

• RESERVE REPO RATE 7.00%RESERVE REPO RATE 7.00%

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