Eco Monetary Policiy

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ONETARY

POLICY AND BY:DHANISHTHAANAND

NIPUNSEHRAWAT



MONETARY

POLICYI. WHAT IS MONETARY POLICY

• Monetary Policy refers to measuresemployed by central banks, currency

boards or other regulatory committeesthat determine the size and rate ofgrowth of the money supply, which inturn aects interest rates.

• Goals of monetary policy:achieve/maintain full employment, ahigh rate of economic growth and tostabilize prices and wages.



In India, the eserve !ank of India isin charge of monetary policy."onetary policy is one of the ways

that the Indian government attemptsto control the economy. If the moneysupply grows too fast, the rate ofin#ation will increase$ if the growth of

the money supply is slowed too much,then economic growth may also slow.



MONETARY POLICYII. Wat i! Money S"##ly

• Money S"##ly refers to the entire stockof currency and other li%uid instruments ina country&s economy as of a particular

time. 'he money supply can include cash,coins and balances held in checking andsavings accounts.

• 'he various types of money in the money

supply are classi(ed as )")s such as "*,"+, ", "-, and ", according to the typeand size of the account in which theinstrument is kept.



TYPES O$ MONEY INMONEY SUPPLY

• M% &M'(ero) is the most li%uid measure of the moneysupply. It only includes cash or assets that could %uicklybe converted into currency. It only includes cash orassets that could %uickly be converted into currency. 'his measure is known as narrow money because it isthe smallest measure of the money supply.

• M* &M'one) includes all physical money, such as coinsand currency, as well as demand deposits, checkingaccounts and egotiable 0rder of 1ithdrawal 2013accounts.

• M+&M't,o) includes cash and checking deposits 2"+3as well as savings deposits, money market mutual fundsand other time deposits, which are less li%uid and not assuitable as e4change mediums but can be %uicklyconverted into cash or checking deposits.

• M-&M'tree) includes " as well as large timedeposits, institutional money market funds, short5termrepurchase agreements and other larger li%uid assets.

• M&M'/o"r) includes "- as well as 6ost 07ce 8eposits.

294cluding ational avings ;erti(cates3



$INANCIAL

MAR0ETSI. WHAT ARE $INANCIAL MAR0ETS

•

< $inancial Mar1et is a market inwhich people and entities can trade(nancial securities, commodities,and other fungible items of value at

low transaction costs and at pricesthat re#ect supply and demand.



$INANCIAL

MAR0ETSII. $INANCIAL MAR0ETS $ACILITATE:

• 'he raising of capital 2in the capital markets3

• 'he transfer of risk 2in the derivatives

markets3• 6rice discovery

• Global transactions with integration of(nancial markets

•

'he transfer of li%uidity 2in the moneymarkets3

• International trade 2in the currency markets3



$INANCIAL

MAR0ETSIII. $UNCTIONS O$ $INANCIAL MAR0ETS

• Intermediary >unctions

• 'ransfer of esources

• 9nhancing income

• 6roductive usage

• ;apital >ormation

•6rice determination

• ale "echanism

• Information

• >inancial >unctions



A$$ECT O$ MONETARYPOLICYON $INANCIAL MAR0ETS

• "onetary policy is aimed at preserving pricestability. In some countries, central banksoperate under mandates that refer to additional

ob?ectives such as full employment, ma4imumsustainable growth, stable interest rates orstable e4change rates.

• >inancial markets are the connecting link in thetransmission mechanism between monetarypolicy and the real economy.

• 'he transmission process from monetary policyto (nancial markets and (nally to the realeconomy has a single source: te 2onetary

#olicy in!tr"2ent.



IN3ESTMENT

MULTIPLIERWHAT IS IN3ESTMENT MULTIPLIER

Investment "ultiplier e4amines theincrease in aggregate income due to an

increase in public or private spending. Itis observed that an increase ininvestment spending has a greater thanproportionate impact on increase in the

ational Income and the generaleconomy.



$or e4a2#le5 let "! a!!"2e tat te 6o7ern2ent !#en8! R! *%%Crore on 8e7elo#in6 in/ra!tr"ct"ral /acilitie!. Since te e4#en8it"reo/ one entity i! te inco2e o/ anoter entity5 ,ic i! a!!"2e8 to9e entity A. $"rter a!!"2in6 tat te Mar6inal Pro#en!ity toCon!"2e i! %.5 i.e. % ;5 it i! i2#lie8 tat e7ery entity !#en8! %

; o/ it! inco2e5 an8 te re!t o/ it !a7e8. T"!5 entity A ,o"l8!#en8 R! % Crore an8 !a7e R! % Crore. No,5 let "! a!!"2e tate4#en8it"re on con!"2#tion 9y entity A i! earne8 9y entity B. No,5entity B a! earne8 R! % Crore5 o"t o/ ,ic5 R! + Crore ,o"l8 9e!#ent an8 R! + Crore ,o"l8 9e !a7e8.

Ti! cycle ,o"l8 contin"e "# till te #oint ,ere Con!"2#tion

9eco2e! ne6li6i9le an8 Total Sa7in6! 9eco2e e<"al to te InitialIn7e!t2ent O"tlay.

Initial O"tlay > R! *%% Crore MPC > %. AND MPS > %.

Inco2e &In R! Crore) Con!"2#tion &In R! Crore) Sa7in6! &In R! Crore)

*%% % %

% + +

+ *+. *+.*+. ?.+ ?.+

. . .

. . .

@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@@

+%% *%% *%%

In7e!t2ent M"lti#lier > **'MPC



INCOME E$$ECTON $INANCIAL MAR0ET

In the diagram, the demand

curve 8 shifts to 8+ with anincrease in income. <s a result ofthis, the e%uilibrium point shiftsfrom 9 to 9+, with thee%uilibrium price increasing to6+ and e%uilibrium %uantityincreasing to 6.<s a result of increased income,the interest rate in the economyfalls. 'his happens because ofthe greater amounts of money

ready to be invested in limited



MONETARY POLICY

INSTRUMENTSI. eserve atios

II. 8iscount ateIII. 0pen "arket 0perations

I@. 8iscount 1indow

@. "oral uasion



RESER3E

REUIREMENTSI. Ca! Re!er7e Ratio &CRR) is aspeci(ed minimum fraction of the totaldeposits of customers, which

commercial banks have to hold asreserves either in cash or as depositswith the central bank.

II. Stat"tory Li<"i8ity Ratio 2SLR3

refers amount that the commercialbanks re%uire to maintain in the form ofgold or govt. approved securities beforeproviding credit to the customers.



RESER3E

REUIREMENTSo;onsidering a situation wherein thegovernment needs to intervene in order toreduce the money supply in the economy,the ;entral !ank may increase the reservere%uirements of banks. 'his would constraintthe li%uid cash available with banks availablefor lending, which would force banks toincrease the rate at which they lend loans,thereby inhibiting the public from raisingloans at higher interest rates. 'his would

ultimately lead to a fall in the money supply.oince a fall in the money supply would imply

that people would have lesser money toinvest in (nancial instruments, it would leadto a leftward shift in their demand curve.



E$$ECT O$ INCREASE INRESER3E REUIREMENTSON EUILIBRIUM PRICE O$

$INANCIAL INSTRUMENTS

In the diagram, thedemand curve 8 shifts

to 8+ with a fall inmoney supply owing toincrease in reservere%uirements . <s aresult of this, thee%uilibrium point shiftsfrom 9 to 9+, with thee%uilibrium price fallingto 6+ and e%uilibrium

%uantity falling to 6.



DISCOUNT RATE0ne of the most important functions of the!I is its role as a lender of last resort to thebanking system. !anks in need of li%uiditymay borrow from the !I at the discount rate.

•Re#o rate is the rate at which the centralbank of a country lends money to commercialbanks in the event of any shortfall of funds.

•Re7er!e re#o rate is the rate at which thecentral bank of a country borrows moneyfrom commercial banks within the country.



DISCOUNT RATEo;onsidering a situation wherein the

government needs to intervene in order toincrease the money supply in the economy, the;entral !ank may decrease the repo rate andthe reverse repo rate. 'his would encouragebanks to borrow money from the ;entral bank,and would discourage them to lend money tothe ;entral bank, thereby leading to anincrease in the money supply.

oince an increase in the money supply wouldimply that people would have more money toinvest in (nancial instruments, it would lead toa rightward shift in their demand curve.



E$$ECT O$ $ALL IN REPO RATE

AND RE3ERSE REPO RATE ONEUILIBRIUM PRICE O$$INANCIAL INSTRUMENTSIn the diagram, thedemand curve 8 shifts

to 8+ with an increasein income. <s a resultof this, the e%uilibriumpoint shifts from 9 to

9+, with thee%uilibrium priceincreasing to 6+ ande%uilibrium %uantity

increasing to 6.



OPEN MAR0ET

OPERATIONSWHAT IS OPEN MAR0ET OPERATIONS

<n open market operation 2also known

as 0"03 is an activity by a centralbank to buy or sell government bondson the open market. < central bankuses them as the primary means ofimplementing monetary policy.



OPEN MAR0ET

OPERATIONS ON $INANCIALMAR0ETS 'he governmentAs most important and widelyused policy tool is open market operations. 'he reserve re%uirement which necessitates

banks to keep +*B of the value of e4istingdeposits on reserve with the !I. 'his givesthe govt. tremendous amounts of money withwhich to engage in (nancial transactions.0pen market operations involve the buyingand selling of government debt 2'reasury!ills, otes, and !onds3. 'he !I makes thesedebt transactions with banks in order to altertotal reserves in the banking system.

E l



E4a2#le:Te RBI ,ant! to "!e o#en 2ar1et o#eration! to increa!e 9an1re!er7e!. Ban1! "!e a #ortion o/ c"!to2er 8e#o!it! &lia9ilitie!) to9"y a!!et! in te /or2 o/ 6o7ern2ent'i!!"e8 8e9t. To increa!e9an1 re!er7e!5 te RBI 9"y! !o2e o/ te 6o7ern2ent 9on8! /ro29an1!.

Wen o#en 2ar1et o#eration! are "!e8 to i2#le2ent are!tricti7e 2onetary #olicy5 te RBI !ell! 9on8! to 9an1!. By#"rca!in6 9on8! /ro2 te RBI5 9an1! a7e le!! 2oney to loano"t an8 te 2onetary 9a!e !rin1!. Te re!"lt i! a re8"ction inte 2oney !"##ly 9y a /actor o/ te 2oney 2"lti#lier. Tere8"ction in te 2oney !"##ly an8 9an1 re!er7e! rai!e! te $e8/"n8! rate "!in6 te o##o!ite o/ te #roce!! 8e!cri9e8 a9o7e. A!lon6'ter2 intere!t rate! increa!e alon6 ,it te RBI /"n8! rate5

9"!ine!! in7e!t2ent an8 con!"2er 9orro,in6 9ot 8ecrea!e5re!"ltin6 in !lo,er DP 6ro,t.

!y applying the above logic

we see, as the since themonetary base of the bankshrinks, banks start to lendless. 0wing to this change insupply of the currency, thedemand reduces.



MORAL SUASION WHAT IS MORAL SUASION

"oral suasion is de(ned in the economic sphereas )the attempt to coerce private economicactivity via governmental e4hortation in

directions not already de(ned or dictated bye4isting statute law.) 'he &moral& aspect comesfrom the pressure for &moral responsibility& tooperate in a way that is consistent withfurthering the good of the economy.

Tere are t,o ty#e! o/ 2oral !"a!ion:

A. P"re Moral S"a!ion.

B. I2#"re Moral S"a!ion.



MORAL SUASION"oral suasion diers from direct suasion usinglaws and regulations in that penalties for non5compliance are not systematically assessed onnon5compliers. 'his has led some authors to

criticise moral suasion as immoral, sincecompliers get penalised for cooperating withthe stated government agenda 2thus incurringe4tra costs3 while non5compliers are notpunished. 0ther ob?ections to the use of moral

suasion include the fact that it constitutese4tra5legal coercion by the government, that itadds uncertainty to the regulatory process, andthat it can undermine or delay theimplementation of eective legislation

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Eco Monetary Policiy