Definition: 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.
Objectives of monetary policy: Maximum feasible output. High rate of growth. Fuller employment. Price stability. Greater equality in the distribution of income and wealth. Healthy balance in balance of payments(BOP).
Quantitative control tools: 1.Open market operations:
It refers to the purchase or sale by the central bank of any securities in which it deals, such as the government securities, banker’s acceptances or foreign exchange.
When central bank offers securities for sale, it intends to contract money supply and credit.
When the central bank pursuing the expansionary monetary policy will buy securities in the market, so that supply and credit capacity will be increased.
OMO’s tools: Repo rate: A repurchase agreement or ready forward deal is a secured short-term (usually 15 days) loan by one bank to another against government securities. Legally, the borrower sells the securities to the lending bank for cash, with the stipulation that at the end of the borrowing term, it will buy back the securities at a slightly higher price, the difference in price representing the interest. Reverse repo rate is the rate that RBI offers the banks for parking their funds with it. Reverse repo operations suck out liquidity from the system.
Bank rate policy: Bank rate is the minimum rate at which the central bank provides loans to the commercial banks. It is also called the discount rate. Dear money policy: Bank rate inc interest rate inc borrowing will be less profitable results contraction of credit. Near money policy: Bank rate dec interest rate low borrowing will be more profitable results expansion of credit.
Reserve requirements changes: The central bank of a country is empowered to determine within statutory limits, the cash reserve requirements of the commercial banks. Statutory liquid ratio: Bank has to keep portion of total deposits with itself in liquid assets. Cash reserve ratio: The percentage of bank’s deposits which they must keep as cash with RBI.
Deficit Financing: It refers to the ways in which the budgetary gap is financed. However, in developing countries, resort is made to the central bank to cover the deficit. The central bank merely release more notes and these are then put into circulation on behalf of the government. Therefore in these countries, deficit financing is tantamount to printing more currency( creation of money).