Medium of exchange
 Unit of account
 Measure of value
 Standard of deferred payments




The classic definition of mo...
M1= currency + demand deposits + other deposits
 M2 = M1 + post office savings deposits
 M3 = M1 + term deposits
 M4 = ...
M 1 = currency in circulation + demand deposits +
other deposits
 M2 = m1 + cds + term deposits less than 1 yr
 M3 = m2 ...








Issue of currency notes
Custodian of foreign exchange reserves
Banker to the Government
Banker to other bank...
Objectives:
a) stabilisation of price level
b) stabilisation of money market
c) promoting economic growth
 Instruments:
a...
Bank rate: rate at which central banks lend to the
commercial banks
 Variable Reserve Ratios
1. cash reserve ratio (crr)
...
CRR

6%

SLR

24%

BANK RATE

6%

REPO RATE

8.5%

REVERSE REPO
RATE

7.5%
Margin requirements
 Regulation of consumer credit
 Credit rationing
 Moral Suasion
 Direct action

Step 1: open market operations (sell securities)
leads to reduction in bank reserves
 Step 2: reduction in money supply
...
liabilities

assets

1. Share capital

1. Cash in hand, cash with central
bank, cash with other banks
2.Money at call

2. ...
An open market purchase of securities by RBI will
result in an increase in reserves spread out
among all the banks.
 If t...
If the reserve requirements are 20%, the Bank A
can lend out Rs 800.
 Every loan creates a deposit . Hence in the
balance...


Total deposit creation will be :
1000+800+640+512…………..
=1000(1+.8+.82+……..)
= 1000(1/1-.8) =5000

Deposit multiplier =...


1.
2.
3.

Limitations to deposit creation:
Public varies its currency holdings
Banks choose to hold excess reserves
Com...
RESERVES

LOANS

Bank A

200

800

DEPOSIT
S
1000

Bank B

160

640

800

Bank C 128

512

640

Bank D 102

410

512

Bank...














If there is a currency withdrawal from Rs 1000.
( CURRENCY DEPOSIT RATIO IS 0.1)
Then the customer...
Liabilities:
 Monetary liabilities are:
 Notes in circulation
 Deposits of financial institutions
 Deposits of foreign...
Non monetary liabilities are:
 Capital account (net worth)
• Paid up capital + contingency reserves
 Government deposits...
FINANCIAL ASSETS:
A. RBI credit to commercial sector

Shares/ bonds of financial institutions

Debentures of co-operativ...
D. Net foreign assets
 Gold coins and bullion
 Foreign securities
 Balances held abroad
OTHER ASSETS :
 Physical asset...
H = Currency + Reserves

◦ Currency is held by public and by banks
◦ Reserves = vault cash + banks deposits
with RBI
= Sta...
Changes in RBI credit to Government
 Changes in RBI credit to commercial bank
 Changes in RBI credit to commercial secto...
Money Supply= currency+deposits
 High powered money(H)= Currency + reserves.
 M = C+D
M/D = C/D+1
=c+1
H/D = C/D +R/D = ...
c=currency deposit ratio
 r =reserve deposit ratio
 M = (1+c)/(c+r)H
 Thus money supply is a multiple of high
powered m...
RBI’s ability to control the stock of money
depends on the control over H and the stability
and predictability of the mone...
Volumes of financial flows can be used to define
various ratios of financial development
 Finance ratios= total financial...


New issue ratio: primary issues/ net physical
capital formation. It shows the degree of financial
dis-intermediation.
(...
Monetary policy2
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Monetary policy2

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Monetary policy2

  1. 1. Medium of exchange  Unit of account  Measure of value  Standard of deferred payments   The classic definition of money is thus “money is what money does”
  2. 2. M1= currency + demand deposits + other deposits  M2 = M1 + post office savings deposits  M3 = M1 + term deposits  M4 = M3+Post office savings deposits 
  3. 3. M 1 = currency in circulation + demand deposits + other deposits  M2 = m1 + cds + term deposits less than 1 yr  M3 = m2 + term deposits exceeding one year + call borrowings from the ndfcs by the banking system  M0 = currency + bankers deposits + other deposits 
  4. 4.       Issue of currency notes Custodian of foreign exchange reserves Banker to the Government Banker to other banks a) custodian of cash reserves b) lender of last resort c) clearing agent Credit control Promotional role
  5. 5. Objectives: a) stabilisation of price level b) stabilisation of money market c) promoting economic growth  Instruments: a) qualitative- controlling the direction of credit b) quantitative – controlling the volume of credit 
  6. 6. Bank rate: rate at which central banks lend to the commercial banks  Variable Reserve Ratios 1. cash reserve ratio (crr) 2. statutory liquidity ratios (slr) 3. repo and reverse repo rates  Open Market operations- buying and selling Government bonds. 
  7. 7. CRR 6% SLR 24% BANK RATE 6% REPO RATE 8.5% REVERSE REPO RATE 7.5%
  8. 8. Margin requirements  Regulation of consumer credit  Credit rationing  Moral Suasion  Direct action 
  9. 9. Step 1: open market operations (sell securities) leads to reduction in bank reserves  Step 2: reduction in money supply  Step 3:this causes interest rates to rise (tight money situation)  Step4:investment falls ( agg. Demand falls)  Step 5: reduction in income, output, employment and prices. 
  10. 10. liabilities assets 1. Share capital 1. Cash in hand, cash with central bank, cash with other banks 2.Money at call 2. Reserve funds 3. Deposits – time, demand savings 4.borrowings 3.Bills discounted including treasury bills 4.Investments 5.Other items 5.Advances 6.others
  11. 11. An open market purchase of securities by RBI will result in an increase in reserves spread out among all the banks.  If the RBI purchases Rs 1000 worth G- secs from a dealer , and pays in cheques.  The dealer will deposit that in the commercial bank A whose deposits increase by 1000 
  12. 12. If the reserve requirements are 20%, the Bank A can lend out Rs 800.  Every loan creates a deposit . Hence in the balance sheet the loans and deposits will increase by 800.  The borrower of 800 will deposit it in his own bank B whose deposits will increase by 800.  Bank B will keep 20%as reserves and lend out 640, thereby creating a new deposit.  The borrower of Rs 640 will deposit in his Bank C. 
  13. 13.  Total deposit creation will be : 1000+800+640+512………….. =1000(1+.8+.82+……..) = 1000(1/1-.8) =5000 Deposit multiplier = 5 = 1/r r= reserve deposit ratio
  14. 14.  1. 2. 3. Limitations to deposit creation: Public varies its currency holdings Banks choose to hold excess reserves Commercial banks have time as well as demand deposits
  15. 15. RESERVES LOANS Bank A 200 800 DEPOSIT S 1000 Bank B 160 640 800 Bank C 128 512 640 Bank D 102 410 512 Bank E 328 410 82
  16. 16.           If there is a currency withdrawal from Rs 1000. ( CURRENCY DEPOSIT RATIO IS 0.1) Then the customer will withdraw Rs 91 in cash and keep Rs 909in deposits. The banks have to keep 20% as crr. So it will lend Rs 727 . C(n+I )+D(n+1) = .8D(n). C(n+1)=.1D(n+1) 1.1D(n+1) = .8D(n) D(n+1)= .727D(n) Total deposits = 909+661+481+… 909[1+.727+(.727)2 +(.727)3 +….] =3330 Total Currency = 0.1(3330) =333
  17. 17. Liabilities:  Monetary liabilities are:  Notes in circulation  Deposits of financial institutions  Deposits of foreign central banks  Accounts of international agencies - IMF  Deposits of banks (Reserves) 
  18. 18. Non monetary liabilities are:  Capital account (net worth) • Paid up capital + contingency reserves  Government deposits  IMF Account no. 1  Misc. – CD, PPF , BILLS  HIGH POWERED MONEY = MONETARY LIABILITIES OF RBI + GOVT MONEY
  19. 19. FINANCIAL ASSETS: A. RBI credit to commercial sector  Shares/ bonds of financial institutions  Debentures of co-operative sector/banks  Loans to financial institutions  Internal bills purchased and discounted B. RBI Credit to Government C. RBI’s gross claims on banks  Refinance of RBI to banks  Fixed investment in bank shares / bonds
  20. 20. D. Net foreign assets  Gold coins and bullion  Foreign securities  Balances held abroad OTHER ASSETS :  Physical assets  Others Monetary liabilities + nonmonetary liabilities = financial assets + other assets
  21. 21. H = Currency + Reserves ◦ Currency is held by public and by banks ◦ Reserves = vault cash + banks deposits with RBI = Statutory reserves +excess reserves (FA)+(OA) = ML+NML FA +OA –NML =ML Let NET NML =NML –OA Thus FA- NNML=ML
  22. 22. Changes in RBI credit to Government  Changes in RBI credit to commercial bank  Changes in RBI credit to commercial sector  Changes in foreign exchange reserves 
  23. 23. Money Supply= currency+deposits  High powered money(H)= Currency + reserves.  M = C+D M/D = C/D+1 =c+1 H/D = C/D +R/D = c+r 
  24. 24. c=currency deposit ratio  r =reserve deposit ratio  M = (1+c)/(c+r)H  Thus money supply is a multiple of high powered money.  c depends on the cost and convenience of holding cash  r depends on regulations as well as interest rate. Reserves include excess cash (vault cash) 
  25. 25. RBI’s ability to control the stock of money depends on the control over H and the stability and predictability of the money multiplier.  Since c cannot be changed easily, any change in the money multiplier is through r 
  26. 26. Volumes of financial flows can be used to define various ratios of financial development  Finance ratios= total financial claims/national income. Shows the relation between financial development and economic development.  Financial interrelations ratio = financial claims/ net physical capital formation. it shows the relation between financial assets and physical assets. 
  27. 27.  New issue ratio: primary issues/ net physical capital formation. It shows the degree of financial dis-intermediation. (primary issues are issued by deficit spenders directly to the surplus spenders)  Intermediation ratio: secondary issues/ primary issues.. It is a measure of financial intermediation.
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