Monetary policy

Monetary policy,objectives, instruments of credit control and transmission mechanism of monetary policy

1. Monetary Policy Sonam Sangwan Assistant Professor, Economics GCW Bawani Khera

2. What is Monetary Policy? Monetary policy is an economic policy that manages the size and growth rate of the money supply in an economy. Monetary policy refers to changes made by a central bank to interest rates and/or the quantity of money in order to achieve changes in aggregate demand that keep inflation within its target range. Monetary policy determines the amount of money that flows through the economy.

3. Objectives of Monetary Policy Full Employment : full employment refers to the situation wherein all persons who are able to work and willing to work at the prevailing rate of wage,get work. Cheap monetary policy→ low rate of interest → expand availability of credit Economic Growth : Economic growth refers to the process of sustained rise in real income per capita. Accordingly the govt. Adopts a monetary policy to accelerate the rate of capital formation which in turn increase production capacity and so level of income. Price stability : Means control of wide fluctuations in the general price level in the economy. Monetary policy seeks to eradicate both inflationary as well as deflationary tendencies in the system. Exchange stability : Stability of BOP (Monetary Policy seeks to regulate foreign exchange reserves in order to control demand and supply parameters) Reduction in Economic inequality

4. Parameters of Monetary Policy Supply of Mone y: Supply of money refers to the currency issued by the monetary authority and the demand deposits with the commercial banks. Rate of interest: Rate of interest is generally sought to be raised during inflation when Expenditure needs to be curbed and it is lowered during depression with a view to increasing the availability of credit. Availability of Money: Availability not money refers to credit control. It is defined as the ease with which at any given rate of interest, money can be borrowed from financial institutions.

5. Instruments of Credit Control Quantitative method Qualitative method Methods of credit control

6. Quantitative Controls The quantitative or general credit control methods adopted by the RBI directly influence the total volume of credit in the economy and also the cost of credit ( rate of interest). The instruments available with the RBI for this method are: Bank rate: It is the rate at which central bank (RBI) lends money to commercial banks by discounting bills of exchange.When the supply of credit increased by commercial banks, it creates inflation and increases the price of necessities. To control such condition central bank increases the bank rate. Open Market Operations: Open Market Operation implies deliberate direct sales and purchase of securities. The Central Bank sells the securities in the open market to decrease the money supply of the banks.OMO lead to expansion of credit when RBI buys securities. Cash Reserve Ratio (CRR): The Cash Reserve Ratio (CRR) is an effective instrument of credit control. Under the RBl Act of, l934 every commercial bank has to keep certain minimum cash reserves with RBI. The RBI is empowered to vary the CRR between 3% and 15%. A high CRR reduces the cash for lending and a low CRR increases the cash for lending.

7. Quantitative Controls Statutory Liquidity Ratio (SLR): Under SLR, the government has imposed an obligation on the banks to; maintain a certain ratio to its total deposits with RBI in the form of liquid assets like cash, gold and other securities. The RBI has power to fix SLR in the range of 25% and 40%. Credit Control Function: Commercial bank in the country creates credit according to the demand in the economy. But if this credit creation is unchecked or unregulated then it leads the economy into inflationary or deflationary cycles.Thus central bank regulates the credit creation capacity of commercial banks by using various credit control tools.

8. Qualitative Controls The qualitative or selective credit control techniques are employed by the RBI to control the direction and use of credit rather than the volume of credit.The selective credit control methods employed by the RBI include: Margin Requirements: The commercial banks generally advance loans to their customers against some security.More generally, the commercial banks do not lend upto the full amount of the security but lend an amount less than its value. A rise in the margin requirements by RBI results in a contraction in the borrowing value of the security and similarly, a fall in the margin requirements results in expansion in the borrowing value of the security. Credit Rationing: Rationing of credit is a method by which the Central Bank seeks to limit the maximum amount of loans and advances and, also in certain cases, fix ceiling for specific categories of loans and advances.

9. Qualitative Controls Moral Suasion: Under Moral Suasion, RBI issues periodical letters to bank to exercise control over credit in general or advances against particular commodities. The policy of moral suasion will succeed only if the Reserve Bank is strong enough to influence the commercial banks Direct Action: It is too severe and is therefore rarely followed. It may involve refusal by RBI to rediscount bills or cancellation of license, if the bank has failed to comply with the directives of RBI.

10. Monetary Policy as instrument to combat inflation: Restraint on New currency
Increase in rate of interest Credit control
Demonetization

11. Monetary policy as an instrument to combat deflation: Increase in Supply of money
Reduction in rate of interest Easy availability of credit

12. Monetary policy and stability of exchange rate: The parameter of supply of money: If imports>exports⟹exchange rate unfavorable⟹supply of money⬇⟹domestic price ⬇⟹exports ⬆and imports ⬇⟹exchange rate will improve. The parameter of cost of money: If imports>exports⟹rate of interest⬇⟹domestic and foreign investment ⬆ ⟹exchange rate improves. The parameter of availability of money: If imports>exports⟹exchange rate unfavorable⟹availability of credit to exporters is facilitated⟹encourage exports⟹exchange rate improves.

13. Monetary policy and Economic Development: Mobilisation of savings
Capital formation Price stability Utilisation of excess capacity

14. Transmission mechanism of monetary policy: The mechanism by which changes in monetary policy affect aggregate demand is called the transmission mechanism. This mechanism works by providing a link between rate of interest and investment and secondly linkiy the investment with the aggregate demand. Monetary policy through its transmission mechanism connects the monetary band real sectors bof the economy.

15. Thank you....😊