• M1 = Currency with public+
Demand deposits with banks+
Other Deposits with RBI
• M2 = M1+ Post Office Deposits
• M3 = M1+ Time Deposits with Banks
• M4 = M3+ Total Post Office Deposits
What is Monetary Policy?
• The term monetary policy refers to actions
taken by central banks to affect monetary
magnitudes or other financial conditions.
• Monetary Policy operates on monetary
magnitudes or variables such as money
supply, interest rates and availability of credit.
• Monetary Policy ultimately operates through
its influence on expenditure flows in the
• In other words affects liquidity and by
affecting liquidity, and thus credit, it affects
total demand in the economy.
Aims of Monetary policy
• MP is a part of general economic policy of the govt.
• Thus MP contributes to the achievement of the goals
of economic policy.
Central Bank Objectives
• Advanced Economies
European Central Bank-Price Stability
Japan-Price Stability & financial Stability
USA –Max employment,Stable prices.
Price Stability: The Dominant
• Price stability does not mean complete year-to-year
price stability which is difficult to attain.
• Price stability refers to the long run average stability
• Price stability involves avoidance of both inflationary
and deflationary pressures.
• Price Stability contributes improvements in the
standard of living of people.
• It promotes saving in the economy while discouraging
• It contributes to the overall financial stability of the
Instruments of Monetary Policy
I. Quantitative or General Controls
• Bank Rate Policy
• Variable Reserve Ratio
• Open Market Operations (OMOs)
II. Qualitative instruments or Selective Controls
Bank Rate Policy
• Bank rate is the minimum rate at which the
central bank of a country provides loans to the
• It is also known as rediscount rate because
central banks earlier used to provide finance to
commercial banks by rediscounting bills of
• Changes in the bank rate affect the credit
creation by banks by altering the cost of credit.
Bank Rate &Supply of money
• Bank rate is an important component of the
supply of money in the economy.
• When bank rate increasing the cost of
borrowing is high and hence results in the
reduction of money supply in the economy.
• During the periods of recession ,growth and
depression bank rate plays a very important
role to increase investment and aggregate
demand in the economy .
• Responsiveness of businessmen to changes in
the lending rate of interest.
For changes in bank rate to cause changes in all
the other interest rate in the market a well
organised money market is needed.
The bank rate can check a boom and inflation
but the role in recovery is limited.
Variable Reserve Ratios
• Banks are required to maintain a certain
percentage of their total demand and time
deposits in the form of reserves or balances with
• It is called Cash Reserve Ratio or CRR
• SLR –Statutory Liquidity Ratio
• Since reserves are high-powered money or base
money, by varying CRR, RBI can reduce or add to
the bank’s required reserves and thus affect
bank’s ability to lend.
• Present CRR Rate :4.00%
• Statutory Liquidity Ratio (SLR)
• In terms of Section 24 (2-A) of the B.R. Act, 1949 all
Scheduled Commercial Banks, in addition to
• the average daily balance which they are required to
maintain under Section 42 of the RBI Act,1934, are
required to maintain in India
• a) in cash, or
• b) in gold valued at a price not exceeding the current
• c) in unencumbered approved securities valued at a
price as specified by the RBI from time to time
• At present, all Scheduled Commercial Banks
are required to maintain a uniform SLR of 25
per cent of the total of their demand and time
liabilities in India as on the last Friday of the
second preceding fortnight which is stipulated
under section 24 of the B.R. Act, 1949.
• an amount of which shall not, at the close of
the business on any day, be less than 25 per
• such other percentage not exceeding 40 per
cent as the RBI may from time to time, by
• in gazette of India, specify, of the total of its
demand and time liabilities in India as on the
• Friday of the second preceding fortnight,
OPEN MARKET OPERATIONS
• It is another important instrument of credit
• OMO means the purchase and sale of securities
by the central bank of the country.
• When central bank sells securities in the open
market it receives payment in the form of
cheque on one of the commercial banks.
• If the purchaser is bank the cheque is drawn
against the purchasing bank.
USE OF OMO
• This method is adopted to make bank rate
• EX: If member bank do not raise lending rates
due to the availability of surplus funds central
bank can withdraw surplus funds by sale of
securities and compels the members banks to
raise the interest rate.
• Note: Once the banks purchase securities surplus funds will be
reduced and banks borrow from central bank and rate of
Limitations of OMO
• The market for securities in short and long
term should be active as in the case of USA
• In India OMO as an instrument did nor play a
significant role .
• General public do not buy more of
• Qualitative instruments or Selective Controls
• It was introduced to check the speculation
activities in the market and control the flow of
• A method through which credit may be extended
to certain areas and contracted to certain other
• This method is very useful during the periods of
business cycles .
• Monetary policy is used as an important technique to
combat the inflationary and deflationary tendencies in
• To overcome the ill effects of business cycles
monetary policy is used as an important tool in the
• Monetary policy is one of the tools that a national
Government uses to influence its economy. Using its
monetary authority to control the supply and
availability of money, a government attempts to
influence the overall level of economic activity in line
with its political objectives
• Every bank is required to maintain at the close of
business every day, a minimum proportion of their Net
Demand and Time Liabilities as liquid assets in the
form of cash, gold and un-encumbered approved
securities. The ratio of liquid assets to demand and
time liabilities is known as Statutory Liquidity Ratio
(SLR). Present SLR is 25%(18.12.2010). RBI is
empowered to increase this ratio up to 40%. An
increase in SLR also restrict the bank’s leverage
position to pump more money into the economy.
Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to
the banks. When the repo rate increases borrowing from RBI becomes more
expensive. Therefore, we can say that in case, RBI wants to make it more
expensive for the banks to borrow money, it increases the repo rate; similarly,
if it wants to make it cheaper for banks to borrow money, it reduces the repo
rate. Present Repo Rate(7.50)23.3.13
Reverse Repo rate is the rate at which banks park their short-term excess
liquidity with the RBI. The RBI uses this tool when it feels there is too much
money floating in the banking system. An increase in the reverse repo rate
means that the RBI will borrow money from the banks at a higher rate of
interest. As a result, banks would prefer to keep their money with the RBI.
Present RRR(6.50) 23.3.13
Thus, we can conclude that Repo Rate signifies the rate at which liquidity is
injected in the banking system by RBI, whereas Reverse repo rate signifies the
rate at which the central bank absorbs liquidity from the banks
Meaning of Fiscal Policy
The word fisc means ‘state treasury’ and
fiscal policy refers to policy concerning the
use of ‘state treasury’ or the govt. finances
to achieve the macroeconomic goals.
It refers to the Revenue and Expenditure policy
of the Govt. which is generally used to cure
recession and maintain economic stability in
• Fiscal Policy And Macroeconomic Goals
• Economic Growth: By creating conditions for increase in
savings & investment.
• •Employment: By encouraging the use of labourabsorbing technology
• •Stabilization: fight with depressionary trends and
booming (overheating) indications in the economy
• •Economic Equality: By reducing the income and wealth
gaps between the rich and poor.
• Balanced Regional Development
• •Price stability: employed to contain inflationary and
deflationary tendencies in the economy.
Instruments of Fiscal Policy
Budgetary surplus and deficit
Taxation –Direct and Indirect
Components of Budget
• Revenue Receipts
• Capital Receipts
• Revenue Expenditure
• Capital Expenditure
RUPEE COMES FROM
Where The Rupee Comes From
service & other taxes 7%
income tax 13%
corporation tax 21%
non-debt capital reciepts 1%
Non Tax revenue 10%
• Where the rupee goes to
state's share of taxes & duties 18%
• non plan assistance to states 5%
• planned state assistance 7%
• central plan 20%
• interest 20%
• defence 12%
• subsidies 7%
• Other Plan expenditure 11%
An important instrument of fiscal policy
State has to fulfill certain social obligations like
providing free public health,education,housing
The responsibility of building the infrastructure
and large capital goods industries,
spending on agricultural sector are the major
reason for the increase in public expenditure.
• An important source of public revenue
• Direct Tax - Includes taxes on personal income,
corporate income tax&taxes on property and
• Indirect Tax – Includes sales tax, excise duty &
customs duty(Import &export duties)
• Developing countries depend on indirect tax
• Important source of public revenue & a common
practice in all the countries.
• They help in the development process like building
infrastructure facilities and for welfare activities
• Government can raise public debt in the form of
voluntary loan or in the form of compulsory loan.
• Example for Compulsory loan –Issue of bonds,
Provident fund etc
Voluntary loan – Example- By issuing bills and
securities in the market
• The fiscal policies have an impact on the
goods market and the monetary policies have
an impact on the asset markets and since the
two markets are connected to each other via
the two macrovariables — output and interest
rates, the policies interact while influencing
the output or the interest rates.
• Deficit financing is an approach to
money management that involves spending
more money than is collected during the same
period. Sometimes referred to as a budget
deficit, this strategy is employed by
corporations and small businesses,
governments at just about every level, and
even household budgets. When used properly,
deficit financing helps to launch a chain of
events that ultimately enhances the financial
condition rather than simply creating debt that
may or may not be repaid.