Money Supply and Monetary Policy Final
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Transcript of Money Supply and Monetary Policy Final
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Money
Functions of money :
Medium of exchange
Unit of accountA standard of deferred payments
A store of Value
To influence the economy of thedynamic function of money
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Money Supply and Monetary Policy
In economics, the money supply or
money stock, is the total amount of
money available in an economy at a
particular point in time
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Aggregate of Money Supply in India
The Reserve Bank of India defines the monetary aggregatesas
Reserve Money (M0): Currency in circulation + Bankersdeposits with the RBI + Other deposits with the RBI
M1: Currency with the public + Deposit money of the public(Demand deposits with the banking system + Otherdeposits with the RBI).
M2: M1 + Savings deposits with Post office savings banks.
M3: M1+ Time deposits with the banking
M4: M3 + All deposits with post office savings banks(excluding National Savings Certificates
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NM1 Currency with the public +
Demand deposits with the
banking system + Other
deposits with the RBI.
NM2 NM1 + Short-term time deposits
of residents (including and up
to the contractual maturity of
one year).
NM3 NM2 + Long-term time deposits
of residents + Call/Term
funding from financial
institutions.
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Liquidity Aggregates
L1 NM3 + All deposits with the
post office savings banks
(excluding National Savings
Certificates).
L2 L1 +Term deposits with term
lending institutions and
refinancing institutions (FIs) +
Term borrowing by FIs +
Certificates of deposit issued by
FIs.
L3 L2 + Public deposits of nonbanking
financial companies
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Determinants of money supply
There are two types of money
M= Ordinary money
H= High powered money or base money
M= C+ DD +OC
H= C + R + OD
The difference between R and DD can be explained
with the concept of credit creation by banks .
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Determinants of Money Supply
Ms= m.H
WhereMs = Money Supply
m=money multiplier
H= High powered money
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Credit creation by commercial banks
Assumption
Currency deposit ratio =c=.5Required reserve ratio = r =0.1
Assets of banks are only loans given by
themBanks offer only demand deposits
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Process
Public comes in possession of H worth Rs 60
crores . Public keep Rs 20 crores in currency
and Rs 40 crores in bank deposits . Banks have
Reseves of Rs 40 crores.As r is .1 banks keep
Rs 4 crores in cash and rest of the money the
lend .
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Deposits Currency Reserves Derivative
deposits
40 20 4 36 Ist round of
credit creation
24 12 2.4 21.6 Second roundcredit creation
14.4 7.2 1.44 12.96
Total = 100 Total =50 Total=10 Total=90 N ROUNDS OF
CREDIT
CREATION
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Various multipliers
Deposit multiplier = 1/(c+r)=1.667
Bank credit multiplier = 1- r/(c+r)=1.5
Money multiplier = 1+c/(c+r) =2.5
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Determinants of money supply
H
C
r
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NUMERICALS
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Answer
Money supply in the economy MS = High powered money x moneymultiplier
Money Multiplier mm =1 +c / c + r
=1 +.20 / .20 + .15
mm =1.20 / .35 =3.4
High powered Money = Credit to govt. + Credit to banks + Credit toCommercial Sector + Foreign Exchange assets +Other Assets Govt.Deposits Net worth Other Non Monetary liabilities
=1650 +520 +140 +25 +15 -80 -350 -10
=1910
High powered Money =1910 +25 (govt. money)
=1935
Money Supply =1935 x 3.4 = 6579
Money Supply = 6579 MUC
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The following balances have been taken from the balance sheet of the Central Bank
of an economyMillion Unit of Currency
Credit to Government 650Credit to Bank 400
Government Deposits 15
Net worth 375
Other None-monetary Liabilities 5
Credit to Commercial Sector 65
Foreign Exchange Assets 20
Other Assets 55
The currency/deposit ratio is 0.35 and the Central Bank imposes a reserve
ratio of 6%. The government money in the economy is negligible and can be
ignored.a. Calculate the money supply in the economy.
b. The country is about receive a foreign aid to the tune of 100
million unit of Currency. What should be the new reserve ratio to
sterilize the effect of the aid on the money supply of the economy?
c. If the Central Bank wishes to sterilize the effect of aid only to the
extent of 50%, what should be the new reserve ratio?
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Answer
A. 2618
B.r= 0.1115 or 11.15%
C. 0.084 or 8.4%
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Monetary policy
The monetary policy of any country refers tothe regulatory policy , whereby the monetaryauthority maintains its control over (i) the
supply of money ii) availability of money, and(iii) cost of money or rate of interest for therealization of general economic goals such asstability of employment, and prices ,
economic growth , and balance ininternational payments .
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Types of monetary policy
Expansionary or Cheap or easy monetary
policy
Contractionary policy ,dear or tight monetarypolicy
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Instruments of
Monetary
policy
Quantitative Tools
Open
Market
Requireme
nts
BankRate
CRR
Secondary
Reserve
Requirements
RepoRate ,Rever
seRepoRates
Qualitative Tools
Rationi
ng ofCredit
Changes
in MarginRequirem
ents
RegulationOf
Consumer
Credit
Moral
Suasion
DirectAction
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Monetary Policy in Developing
Economy
The objective of the Monetary policy is growth
with equity . But the monetary policy is not
effective due to existence of Large organize
sector , time lags in the monetary policy .
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Conclusion
Monetary and fiscal policies are
interdependent . For example if the
government adopts the deficit financing than
RBI can adopt a tight money policy. The
objective of the Monetary policy is growth
with stability . But the monetary policy is not
effective due to existence of Largeunorganized sector , time lags in the monetary
policy .
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Current Rates
Bank Rate : 6 %
Repo Rate :8.5
Reverse Repo Rate :7.5%
CRR: 6% SLR:24%
Base Rate : 10.00-10.75%
Saving BANK Rate : 4%
Deposit Rate 8.5-9.5% Call Rates : 7.0- 9.75%
Marginal Standing Facility Rate : 9.5%
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Monetary Policy in India
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Current ates
Bank Rate : 6 %
Repo Rate :8.5
Reverse Repo Rate :7.5%
CRR: 6% SLR:24%
Base Rate : 10.00-10.75%
Saving BANK Rate : 4%
Deposit Rate 8.5-9.5% Call Rates : 7.0- 9.75%
Marginal Standing Facility Rate : 9.5%