Monetary policy 1 0810


Published on

Published in: Education
1 Comment
No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Monetary policy 1 0810

  1. 1. Central Banks and Monetary Policy
  2. 2. <ul><li>Central Bank </li></ul><ul><ul><li>Apex institution of the monetary system </li></ul></ul><ul><ul><ul><li>Regulate the functioning of the commercial banks of the country </li></ul></ul></ul><ul><ul><ul><li>Promote the financial and economic stability of a country </li></ul></ul></ul><ul><ul><ul><li>Regulate credit and money supply in the country </li></ul></ul></ul>
  3. 3. Functions of a Central Bank <ul><li>Note Issuing Agency </li></ul><ul><li>Banker to the State </li></ul><ul><li>Bankers Banker </li></ul><ul><li>Controls Credit </li></ul><ul><li>Lender of the Last Resort </li></ul><ul><li>Manages Exchange Rate. </li></ul>
  4. 4. Note Issuing Agency <ul><li>Monopoly over issuing notes in the country </li></ul><ul><ul><li>Exceptions are One rupee notes </li></ul></ul><ul><li>Minimum reserve system </li></ul><ul><ul><li>Maintenance of minimum reserve of gold and foreign exchange securities based on which currency is printed. </li></ul></ul>
  5. 5. Banker to the State <ul><li>Balances of central government kept with RBI </li></ul><ul><ul><li>No interest payment on this </li></ul></ul><ul><li>Receives and makes payment on behalf of the government </li></ul><ul><li>Arranging new loans for central government </li></ul><ul><li>Manages public debt </li></ul><ul><li>Lends to the central government </li></ul>
  6. 6. Banker’s Banker <ul><li>Custodian of the cash reserve of the commercial banks </li></ul><ul><li>Lender of the last resort </li></ul><ul><li>As a bank of central clearance, settlement and transfer. </li></ul>
  7. 7. Lender of Last Resort <ul><li>Commercial banks can approach Central Bank for loan in times of emergency </li></ul><ul><li>Loan issued on the strength of foreign securities or by discounting of bills </li></ul>
  8. 8. Central Bank and Monetary Policy <ul><li>INSTRUMENTS OF CREDIT CONTROL </li></ul><ul><li>Change in Reserve ratio </li></ul><ul><li>Open Market Operations </li></ul><ul><li>Direct Credit Control </li></ul><ul><li>Change in Bank rate </li></ul>
  9. 9. Cash Reserve Ratio <ul><li>The RBI insists that the commercial banks keep a certain proportion(%) of their deposit as a reserve with the RBI. </li></ul><ul><ul><li>This is done to control the money supply in the economy. </li></ul></ul><ul><ul><li>Depending on the requirement the central bank RBI can increase (or decrease ) the reserve ratio to increase (decrease) the money supply. </li></ul></ul>
  10. 10. Statutory Liquidity Ratio <ul><li>A certain percent of the commercial bank’s deposit should be invested in government bonds and treasury bills. </li></ul><ul><ul><li>These treasury bills can be discounted in times of emergency. </li></ul></ul><ul><ul><li>Mechanism for credit control. </li></ul></ul>
  11. 11. Open Market Operations <ul><li>Powerful tool of monetary policy. </li></ul><ul><li>If the central bank wants to increase the money supply into the financial system it can buy government securities from the open market. </li></ul><ul><li>Similarly if the central bank wants to reduce the money supply it would sell government security in the open market. </li></ul>
  12. 12. <ul><li>The buyer of the security writes a cheque drawn on his bank( commercial bank) in favour of the central bank. </li></ul><ul><li>The reserves of the commercial bank is reduced while paying the central bank. </li></ul><ul><li>Credit creation capacity of the commercial bank is also reduced. </li></ul>
  13. 13. Changing the bank rate: <ul><li>The interest charged by the central bank on the amount given as loan to the commercial bank (for meeting the depositors demand and reserve requirements) is known as bank rate. </li></ul>
  14. 14. <ul><li>The central bank can influence the money supply growth by changing the bank rate from time to time. </li></ul><ul><ul><li>If the central bank wants to inject more liquidity into the banking system it will lower the bank rate. </li></ul></ul><ul><ul><li>Commercial banks would borrow more and this would increase the money supply. </li></ul></ul><ul><ul><li>Exactly opposite would happen if the central bank wants to decrease the money supply (or credit creation) of the economy. It would increase the bank rate. </li></ul></ul>
  15. 15. Direct Credit Control <ul><li>The central bank can administer the interest rates directly. </li></ul><ul><li>Fix the quantity of bank deposit </li></ul><ul><li>Direct the allocation of credit. </li></ul>