2. Introduction
Meaning
Definition
Objectives
Instruments of monetary policy
i. Quantitative instruments
ii. Qualitative instruments
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3. Monetary policy plays a significant role in the
economic development of a nation. Under
monetary policy, different measures are
undertaken by the Central Bank (Reserve Bank
of India) in order to control and regulate the
volume of currency and credit in a nation.
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4. Monetary policy is a policy which influences the
public’s stock of money substitutes of the
public’s demand for such assets, or both-that
is, policy which influences the public’s liquidity
positions.
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5. According to Harry G. Johnson, Monetary
policy is a “policy employing the central bank’s
control of the supply as an instrument for
achieving the objectives of the general
economic policy.”
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6. The objectives of monetary policy is developed and
developing economy are slightly different. The main
objectives of monetary policy are discussed as under:
Price Stability
Monetary Equilibrium
Full Employment
High Rate of Growth
Reducing Inequalities of Income
Capital Formation
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7. The instruments of monetary policy are broadly
classified into two categories:
Quantitative Instruments
Qualitative Instruments
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8. Bank Rate: The bank rate is the minimum rate in
which the central bank of a country is prepared to
give credit to the commercial bank. When central
bank wishes to control the credit and inflation it
raises the bank rate. Increased bank rate increases
the cost of borrowing of the commercial bank who in
turn charges a higher rate of interest from their
borrowers. As a result, the demand for the credit will
go down. Central bank adopts dear money policy
when the supply of credit needs to be reduced during
period of inflation. It adopts cheap money policy
when credit needs to be expanded during deflation.
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9. Open Market Operation: Open market
operation refers to the sale and purchase of
securities in the open market by the central
bank. By selling securities central bank
withdraws cash balances from the country. On
the other hand, by buying the securities
central bank contributes to cash balance in
the economy. Through open market
operation, if cash balance are increased, the
flow of credit will increase and if cash balance
is reduced, the flow of credit will decrease.
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10. Cash Reserve Ratio: It refers to that portion of the
total deposit which a commercial bank has to
keep with the central bank in the form of cash
reserve. When cash flow or credit is to be
increased, minimum reserve ratio is reduced and
when cash flow or credit is to be reduced,
minimum cash reserve ratio is increased.
Statutory Liquidity Ratio: It refers to that portion of
the total deposit which a commercial bank has to
keep with itself in the form of liquid assets. To
reduce the flow of credit in the market, central
bank increases this liquidity ratio. In case of
expansion of credit, liquidity ratio is reduced.
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11. Margin Requirements: It refers to the
difference between the current value of the
security offered for loan and the value of loan
granted.
Rationing of Credit: It refers to fixation of
credit quotas for different business activities.
Central bank fixes the quota for different
business activities. The commercial bank can
not exceeds the limit while granting loans. It
is used generally to check for speculative
activities.
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12. Direct Action: If members banks do not
comply with the directives, direction action is
taken. Derecognition of commercial bank as a
member of the country’s banking system.
Moral Suasion: Central bank makes members
banks agree pressure to follow its directives
with a view to control the flow of credit.
Central bank is the controller of all the
commercial bank. Therefore, these bank
follow the advice in relation the flow of credit.
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