Broader role for Monetary Policy

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Sudarshan Kumar Patel

Chandan Kumar Ravi

EDITORIAL-THE HINDU BUSINESS LINE

Date- Friday ,February 3, 2012

Author-

K. Kanagasabapathy

Director EPW Research Foundation

About………….

Monetary Policy

Unsustainable sovereign debt

Euro crisis

2008-09 crisis

Governor – D Subbarao

Different Instrument

a. Quantitative

b. Qualitative

Financial stability

Public Debt Suistanability

Introduction

CD Deshmukh The First Indian Governor ofReserve Bank of India (RBI

Raghu ram Rajan,Present Governor

Unsustainable Sovereign Debt

Bonds issued by a national government in a foreign currency, in order to finance the issuing country's growth. Sovereign debt is generally a riskier investment when it comes from a developing country, and a safer investment when it comes from a developed country. The stability of the issuing government is an important factor to consider, when assessing the risk of investing in sovereign debt, and sovereign credit ratings help investors weigh this risk.

Monetary policy- Meaning

The part of the economic policy which regulates the level of money in the economy in order to achieve certain objectives.

In INDIA,RBI controls the monetary policy. It is announced twice a year, through which RBI,regulate the price stability for the economy.

Cont……………….

Monetary Policy is the process bywhich the monetary authority of acountry controls the supply of

money,often targeting the interest rate for

thepurpose of promoting economic

growthand stability .

According to Harry G. Johnson

“Monetary policy employing the central bank’s control of supply of money as an instrument for achieving the objectives of general economic policy.”

Nature of Monetary Policy

• Monetary policy uses a variety of tools (interest rate) to control influence outcome like(economic growth , inflation, exchange rate with other currencies and unemployment).

• It controls the supply of money

• Monetary policy works through expansion or contraction of investment and consumption expenditure.

Objectives of Monetary Policy

There are basically three major objectives of

monetary Policy. Which are:-

To ensure price stability.

To encourage economic growth.

To ensure stability of exchange rate of money.

Inflation

Inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services. A chief measure of price inflation is the inflation rate.When Prices rise the Value of Money falls.

STAGES OF INFLATION

• 1. CREEPING INFLATION (0%-3%)

• 2. WALKING INFLATION ( 3% - 7%)

• 3. RUNNING INFLATION (10% - 20 %)

• 4. HYPER INFLATION ( 20% and abv)

Importance of Monetary Policy

• Gross National Product (GNP) = C + I + G + X

• Where: C = Private Consumption expenditure• I = Private Investment Expenditure• G = Government Expenditure• X = Net Exports

• C, I, X can be influenced by the monetary policy which can also influence the private consumption and investment spending and exports and imports

INSTRUMENTS OF MONETARY POLICY

• 1. Bank Rate of Interest

• 2. Cash Reserve Ratio

• 3. Statutory Liquidity Ratio

• 4. Open market Operations

• 5. Margin Requirements

• 6. Deficit Financing

• 7. Issue of New Currency

• 8. Credit Control

Bank Rate of Interest

It is the interest rate which is fixed by the RBI to control the lending capacity of Commercial banks . During Inflation , RBI increases the bank rate of interest due to which borrowing power of commercial banks reduces which thereby reduces the supply of money or credit in the economy .When Money supply Reduces it reduces the purchasing power and thereby curtailing Consumption and lowering Prices.

Cash Reserve Ratio

CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. During Inflation RBI increases the CRR due to which commercial banks have to keep a greater portion of their deposits with the RBI . This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation.

Statutory Liquidity Ratio

Banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements . If SLR increases the lending capacity of commercial banks decreases thereby regulating the supply of money in the economy.

Open market Operations

It refers to the buying and selling of Govt. securities in the open market . During inflation RBI sells securities in the open market which leads to transfer of money to RBI.Thus money supply is controlled in the economy

MONETARY POLICY :KEYNESIAN VIEW

EXPANSIONARY MONETARY POLICY

Measures :1. Central bank buys securities through open

market operation

2. It reduces CRR

3. It lowers bank rate

Money supply increase

Interest rate falls

Investment increase

Aggregate demand increase Aggregate output increase

TIGHT MONETARY POLICY

Problem : Inflation

Measures : 1. Central bank sells securities through

open market operation

2. It raises CRR & SLR bank rate

3. It raises maximum margin against holding of stocks of goods

• Money supply decrease

• Interest rate decrease

• Investment expenditure declines

• Aggregate demand declines

• price level falls