Economic activity-the amount of buying and selling in the economy
Short-term interest rates set by the Monetary Policy Committee (MPC) of the Bank of EnglandMeets for 2 days each month to decide on rates
How central bank determines short term interest rates: toolsOpen market operationDiscount window leadingReserve requirements policyLending by the Central BankInterest RateDirect Credit ControlMoral SuasionPrudential GuidelinesExchange RateCurrency board
What is Monetary Policy• The term monetary policy refers to actions taken by central banks to affect monetary magnitudes or other financial conditions• Attempts to influence the level of economic activity through changes to the amount of money in circulation and the price of money – short-term interest rates• The money supply can/does influence price levels Inflation occurs if the money supply increases, ceteris paribus. Deflation occurs if the money supply decreases, ceteris paribus.
Continue….• Interest rates the key area of Monetary Policy• Basis of Monetary Policy is that there is a long run relationship between the amount of money and inflationMain circumstances:- (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest to attain a set of objectives oriented towards the growth and stability of the economy.
Aims of Monetary policy• MP is a part of general economic policy of the government• Thus MP contributes to the achievement of the goals of economic policy• MP also fulfill following aims also:- Full employment Stable exchange rate Economic growth Reasonable Price Stability Greater equality in distribution of income & wealth Financial stability
OBJECTIVES OF MONETARY POLICY Price stability Credit availability Stability of exchange rate Full employment High rate of economics growth Distribution of money
Price Stability: The Dominant Objective• There is convergence of views in developed and developing economies, that price stability is the dominant objective of monetary policy.• 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 of prices.• Price stability involves avoidance of both inflationary and deflationary pressures.
Continue…• Price Stability contributes improvements in the standard of living of people.• It promotes saving in the economy while discouraging unproductive investment.• Price stability leads to interest rate stability, and exchange rate stability (via export import stability).• It contributes to the overall financial stability of the economy.
Major players Reserve Bank presidents Federal Open Market Committee(FOMC) Direct open market operations Chair of the Board Advises on discount rate andBoard of Governors of GovernorsApproves discount reserve requirementsratesset reserverequirement 6 Governors of theDirects regulatory Boardoperations
Types of monetary policyThe distinction between the various types of monetary policy lies primarily withthe set of instruments and target variables that are used by the monetaryauthority to achieve their goals Monetary Policy: Target Market Variable: Long Term Objective:Inflation Targeting Interest rate on overnight debt A given rate of change in the CPIPrice Level Targeting Interest rate on overnight debt A specific CPI numberMonetary Aggregates The growth in money supply A given rate of change in the CPIFixed Exchange Rate The spot price of the currency The spot price of the currency Low inflation as measured byGold Standard The spot price of gold the gold price Usually unemployment + CPIMixed Policy Usually interest rates change
Instruments of Monetary Policy• Variations in Reserve Ratios• Discount Rate (Bank Rate) (also called rediscount rate)• Open Market Operations (OMOs)• Other Instruments
RBI Annual Policy StatementThe Statement consists of two parts: Part I. Annual Statement on Monetary Policy for the Year 2012-13; and Part II. Annual Statement on Developmental and Regulatory Policies for the Year 2012-13• First Quarter Review in July• Mid-term Review in October,• Third Quarter Review in January
Monetary policy Consists:-• The State of The Economy Global Economy Domestic economyInflationMonetary Aggregates
Monetary MeasuresRepo Rate under LAF- 7.75% (Decreased from 8.00%)Cash Reserve Ratio (CRR)- 4.00%(Decreased from 4.25%)Bank Rate- 8.75%(decrease from 9.0- previous quater)Statutory Liquidity Ratio (SLR)- 23%Reverse Repo Rate under LAF- 6.75%(Decreased from 7.00%)