3. Monetary Policy –Meaning….
Reserve Bank of India states that,
• Monetary policy refers to the use of instruments under the control of
the central bank to regulate the availability, cost and use of money
and credit.
4. Objectives
• Maintaining price stability
• Ensuring adequate flow of credit to the productive Sectors of
the economy to support economic growth
• Rapid economic growth
• Balance of payment equilibrium
• Full employment
• Equal income distribution
5. Methods
• The RBI aims to achieve its objectives of economic growth and
control of inflation through various methods.
These methods can be grouped as:
– General/ quantitative methods
– Selective/ qualitative methods
6. General/ Quantitative methods
• These methods maintain and control the total quantity or
volume of credit or money supply in the economy.
– Open Market Operations
• Open market operations indicate the buying/ selling of govt. securities in the open market to balance
the money supply in the economy
– Deployment of Credit
• The RBI has taken various measures to deploy credit in different sector of the economy. The certain
%age of the bank credit has been fixed for various sectors like agriculture, export etc.
7. Direct Instruments
Cash reserve ratio (CRR)
The money supply in the economy is influenced by CRR.
It is the ratio of a bank’s time and demand liabilities to be kept in reserve with the RBI.
The RBI is authorized to vary the CRR between 3% and 15%.
Statutory liquidity ratio (SLR):
Under SLR, banks have to invest a certain percentage of its time and demand liabilities in govt. approved
securities.
The reduction in SLR enhances the liquidity of commercial banks.
8. Indirect Instruments
Liquidity Adjustment Facility (LAF):
– Consists of daily infusion or absorption of liquidity on a repurchase basis,
through repo (liquidity injection) and reverse repo (liquidity absorption)
auction operations, using government securities as collateral.
i. Repo Rate:
– Repo rate is the rate at which the RBI lends shot-term money to the banks
against securities. When the repo rate increases borrowing from RBI becomes
more expensive.
ii. Reverse Repo Rate:
– The rate at which RBI borrows from commercial banks.
9. • Marginal Standing Facility (MSF):
Instituted under which scheduled commercial banks
can borrow over night at their discretion up to one per
cent of their respective NDTL at 100 basis points above
the repo rate to provide a safety valve against
unanticipated liquidity shocks
• Bank rate:
Bank Rate is the rate at which central bank of the
country (in India it is RBI) allows finance to
commercial banks.
Bank Rate is a tool, which central bank uses for short-
term purposes.
Any upward revision in Bank Rate by central bank is an
indication that banks should also increase deposit
rates as well as Base Rate / Benchmark Prime Lending
Rate.
• Market Stabilization Scheme (MSS):
Liquidity of a more enduring nature arising from large
capital flows is absorbed through sale of short-dated
government securities and treasury bills.
The mobilized cash is held in a separate government
account with the Reserve Bank.
10. SELECTIVE/ QUALITATIVE MEASURES
• The RBI directs commercial banks to meet their social obligations through selective/ qualitative
measures.
• These measures control the distribution and direction of credit to various sectors of the economy.
CEILING ON CREDIT
MARGIN REQUIREMENTS
DISCRIMINATORY RATES OF INTEREST
11. FACTORS AFFECTING MONETARY POLICY
There exist a non-monetized sector
Excess of non-banking financial institutions (NBFI)
Existence of unorganized financial market
Money not appearing in an economy
Time lag affects success of monetary policy
Monetary policy and fiscal policy lacks coordination
12. INFLATION
• Inflation is broadly understood as the general rise in the prices
of goods and services year on year, inflation is a more complex
phenomena associated with the money supply and currency
values.
13. Causes of Inflation
Inflation due to Monetary expansion (Monetary inflation)
Inflation due to rise in real aggregate demand (Real inflation)
Inflation due to contraction in Aggregate Supply
14. Problems caused by Inflation
• High and persistent inflation imposes significant socio-economic
costs.
• High inflation distorts economic incentives by diverting resources
away from productive investment to speculative activities.
• Inflation reduces households saving as they try to maintain the
real value of their consumption.
• If domestic inflation remains persistently higher than those of the
trading partners, it affects external competitiveness through
appreciation of the real exchange rate.
The Reserve Bank’s current assessment suggests that the threshold
level of inflation for India is in the range of 4–6 per cent.
15. How does monetary policy affect inflation
and other problems?
raises
decreases
