MONEY
Medium of Exchange Store Value Standard of Deferred Payments
Unit of Account
DEMAND FOR MONEY
Transaction Demand for Money Precautionary Demand for Money Speculative Demand for Money Total Demand for Money Depends positively on the real GDP and price level due to transactionary and precautionary reasons Real money demand is dependent on real output and overall interest rate.
SUPPLY OF MONEY
Money Supply Classification of Sectors Money Creating Sectors Government Central Bank Commercial Bank Money Using Sectors Households Financial Enterprises Other than Banks Non-financial Enterprises
Rest of the world
MONEY MEASUREMENTS MONEY SUPPLY
M1 =Currency notes and coins with public (excluding cash in hand of all commercial banks) + Demand deposits (excluding inter-bank deposits) of all commercial banks and cooperative banks + Other deposits held by the RBI (includes demand deposits of Quasi government institutions like the IFC, SFC, IDB, ARDC, deposits of the IMF) M2 = M1 + Post office saving deposits (these deposits cannot be withdrawn by cheque) M3 = M1 + Time deposits of all commercial and cooperative banks (excluding inter-bank time deposits) M4 = M3 + Total deposits with the post office saving organizations (excluding NSC)
PROCESS OF CREDIT CREATION
Fractional Reserve System: Only a fraction of a bank deposits are kept as reserves (cash and other highly liquid assets) available for withdrawal.[The bank lends out some or most of the deposited funds, while still allowing all deposits to be withdrawn upon demand.
MONETARY POLICY
Monetary Policy can be defined as a deliberate effort by the central bank to influence economic activity by variations in money supply, availability of credit or interest rate consistent with specific national objective.
OBJECTIVES OF MONETARY POLICY
Price Stability Exchange Stability Full Employment and Maximum output
High Rate of Growth by balancing aggregate monetary demand and supply of goods and services & increasing savings as well investments by firms
RELEVANCE OF MONETARY POLICY
Helps in maintaining control over supply od money by altering interest rates etc. Realize economic objectives of growth, social justice and price stability
Check inflation
INSTRUMENTS OF MONETARY POLICY
Open Market operations Bank Rate Policy Reserve requirement changes
Selective credit controls
OPEN MARKET OPERATIONS (OMO)
The buying of securities by the central bank reduces the quantity of money and credit as well. When the Central Bank offers to sell securities, people withdraw their money from the banks to buy securities. This reduces the cash reserves in the banks. When the Central Bank buys securities, there will be an increase in commercial banks deposits resulting in the increase in the customers deposit with the banks. This improves the cash reserves in the banks and money supply.
BANK RATE POLICY
Bank rate is the rate at which the Central Bank rediscounts approved bills of exchange. It is assumed that market rates change in response to the bank rates.
RESERVE REQUIREMENTS
Central Bank fixes statutory limits of cash reserves requirements for banks. It compels the commercial banks to maintain a minimum % of their deposits as reserves.
Statutory Liquidity Ratio (SLR) is the amount of liquid assets, such as cash, precious metals or other approved securities, that a financial institution must maintain as reserves other than the Cash with the Central Bank. Currently it is 24%
The objectives of SLR are: 1) To restrict the expansion of bank credit.
2) To augment the investment of the banks in Government securities.
3) To ensure solvency of banks. The quantum is specified as 24% of the total demand and time liabilities ( i.e. the liabilities of the bank which are payable on demand anytime, and those liabilities which are accruing in one months time due to maturity) of a bank.
RESERVE REQUIREMENTS
Cash reserve ratio is a central bank regulation that sets the minimum reserves each commercial bank must hold (rather than lend out) of customer deposits and notes. It is normally in the form of cash stored physically in a bank vault (vault cash) or deposits made with a central bank
CRR Ratio currently is 6%.
To curb inflation, Higher the reserve requirement is set, so that less money banks will have to loan out, leading to lower money creation, and maintaining the purchasing power of the currency previously in use. The effect is exponential, because money that is loaned out can be redeposited; a portion of that money may again be re-loaned, and so on.
SELECTIVE CREDIT CONTROL
It is a qualitative method of credit control. Various methods used under selective credit control are: 1) Rationing of credit 2) Direct action 3) Changes in margin requirements
4) Regulation of consumer credit
5) Moral suasion
SELECTIVE CREDIT CONTROL
Credit Rationing is used to prevent excessive credit expansion. Direct Action are various measures that Central Bank takes against banks & FI not adhering to regulations
Central Bank makes changes to margin requirements to curb speculative activities.
Central Bank regulates consumer credit through various regulations. Moral suasion is used to put pressure on the banks to give worthy credit only.
PROBLEMS IN MONETARY POLICY
Lags in Monetary Policy Pressure of Financial Intermediaries like insurance companies, pension funds, cooperative banks Contradiction in Objectives Underdeveloped nature of money and capital markets
MONETARY POLICY IN INDIA
Monetary Policy in India is announced by the RBI once a year and reviewed every quarter for any changes to be incorporated after collecting statistical information on various indicators from the Central Statistical Organization (CSO) In its Monetary policy, RBI also defines interest rates which lay a foundation for credit policy of the commercial banks. As per the instructions of government of India, RBI has implemented priority sector lending, the interest rates are less than commercial interest rates.
MONETARY POLICY IN OPEN ECONOMY
Primary aim to manage reserve flows, exchange rates and monitor international financial developments. A major chunk of international monetary transactions take place in terms of US dollar. India keeps reserves of currencies of the countries with which it has major transactions. Through efficiently and timely trading of the foreign currencies, central bank sterilizes the negative effect of on the foreign currency rate. 2 types of currency rate floating and fixed exchange rates
Floating exchange rate market determined rate
Fixed exchange rate currencies are pegged with other countries. These types of economies align their monetary policies with the country with whom the currency is pegged.
LINK BETWEEN FISCAL & MONETARY POLICY
Both aim at economic growth and are interdependent, Fiscal Policy determines the direction of the monetary policy and based of the required monetary control, fiscal policy is devised. Often to correct tor counter the adverse effect of fiscal policies, monetary policies are used. In the event of increased deficit financing, there would be increase in liquidity as well. To bring liquidity in control, the central bank has to follow tight monetary policy. RBI increase CRR & SLR
