The document discusses various aspects of monetary policy and international monetary systems. It provides details on tools of monetary policy like bank rate policy, open market operations, and changing cash reserve ratios. It also discusses different stages of the international monetary system, including the classical gold standard between 1816-1914 where currencies were pegged to the British pound and gold.

1. Monetary Policy

2. Monetary Policy
It is concerned with the changing the supply of money stock
and rate of interest for the purpose of stabilizing the economy
at full employment or potential output level by influencing
the level of aggregate demand. At times of recession
monetary policy involves the adoption of some monetary
tools which tends to increase the money supply and lower
interest rate so as to stimulate aggregate demand in the
economy. At the time of inflation monetary policy seeks to
contract aggregate spending by tightening the money supply
or raising the rate of return.

3. Objectives
• To ensure the economic stability at full
employment or potential level of output.
• To achieve price stability by controlling
inflation and deflation.
• To promote and encourage economic growth in
the economy.

4. Tools of Monetary Policy
• Bank rate policy
• Open market operations
• Changing cash reserve ratio
• Undertaking selective credit controls

5. Bank Rate Policy
• Bank rate is the minimum rate at which the
central bank of a country provides loan to the
commercial bank of the country.
• Bank rate is also called discount rate because
bank provide finance to the commercial bank by
rediscounting the bills of exchange.
• When general bank raises the bank rate, the
commercial bank raises their lending rates, it
results in less borrowings and reduces money
supply in the economy.

6. Limitations
• Well organized money market should exist in
the economy. It is not present in India
• It is use full during the times of inflation but it
does not full fill its purpose during the time of
recession or depression.

7. Open Market Operations
• It means the purchase and sale of securities
by central bank of the country.
• It is useful for the developed countries.
• The sale of security by the central bank leads
to contraction of credit and purchase there of
to credit expansion.

8. Limitations
• When the central bank purchases the securities the
cash reserve of member bank will be increased and
vise versa.
• The bank will expand and contract credit according to
prevailing economic and political circumstances and
not merely with reference to their cash reserves.
• When the commercial bank cash balance increase the
demand for loan and advance should increase. This
may not happen due to economic and political
uncertainty.
• The circulation of bank credit should have a constant
velocity.

9. Changing Cash Reserve Ratio
• The bank have to keep certain amount of bank
money with them selves as reserves against
deposits.
• The increase in the cash rate leads to the
contraction of credit only when the banks
excess reserves.
• The decrease in the cash rate leads to the
expansion of credit and banks tends to make
more available to borrowers.

10. Expansionary Monetary Policy
Problem: Recession and unemployment
Measures: (1) Central bank buys securities through open
market operation
(2) It reduces cash reserves ratio
(3) It lowers the bank rate
Money supply increases
Investment increases
Aggregate demand increases
Aggregate output increases by a multiple of the
increase in investment

11. Tight Monetary Policy
Problem: Inflation
Measures: (1) Central bank sells securities through open market operation
(2) It raises cash reserve ratio and statutory liquidity
(3) It raises bank rate
(4) It raises maximum margin against holding of stocks of goods
Money supply decreases
Interest rate raises
Investment expenditure declines
Aggregate demand declines
Price level falls

12. Sources of Monetary Mismanagement
• Variable time lags concerning the effect of money
supply on the national income.
• Treating Interest rate as the target of monetary
policy for influencing investment demand for
stabilizing the economy.

13. Role of Monetary Policy in Economic
Growth
• Monetary policy and savings.
• Monetary policy and investment.
– Cost of credit..
– Monetary policy and public investment.
– Monetary policy and private investment.
• Allocation of investment funds.

14. Monetary Policy of RBI
• In recent years starting from the mid-nineties
promoting economic growth is being given greater
emphasis in monetary policy of RBI.
• Three sub-periods:
– Monetary policy of controlled examination(1951-1972).
– Monetary policy in the pre-reforms period(1972-1991) .
– Monetary policy in the post-reforms period(1991-
2000).

15. Monetary policy of controlled examination(1951-1972)
• Reserve bank’s responsibility in the circumstances
is mainly to moderate the expansion of credit and
money supply in such a way as to ensure the
legitimate requirements of industry and trade
and curb the use of credit for unproductive and
speculative purposes.
• To ensure controlled expansion, RBI used the
instruments:
– Changes in bank rate
– Changes in cash reserve ratio
– Selective credit control

16. Monetary policy in the pre-reforms
period(1972-1991)
• Price situation worsened during the years of
1972-1974 to contain inflationary pressures
RBI further tightened its monetary policy.
• It is similar to tight monetary policy.

17. Easy and Liberal Monetary
Policy(1996)
• Liberal monetary policy adopted for encouraging
private sector since 1996.
• Two instrument for monetary management BY
RBI since 1996:
– Reactivation of bank rate.
– Repo rate system .

18. Repo Rate System
• It is introduced through which RBI can add to
liquidity in the banking system. Through repo
system RBI buys securities from the bank and there
by provide funds to them.
• Repo refers to agreement for a transaction between
RBI and banks through which RBI supplies funds
immediately against government securities and
simultaneously agree to repurchase the same or
similar securities after a specified time which may
be one day to 14 days.

19. Liquidity Adjustment Facility
• It is the another instrument of monetary policy
from June 2000 to adjust on a daily basis
liquidity in the banking system.
• Through LAF, RBI regulates short-term interest
rates while its bank rate policy serves as a
signaling device for its interest rate policy in the
intermediate period.

20. 4th Bi-monthly Monetary Policy
• The Reserve Bank of India (RBI) presented its 4th Bi-monthly
Monetary Policy review on 30 September 2014.
• RBI kept the major rates unchanged as the central bank kept
its focus on tackling inflation. Following are the major rates
and projections coming out of this review:
– GDP growth rate projected at 5.5% for current fiscal.
– The high growth rate during Q-1 (Apr-June 2014) may not be
sustained in Q-2 and Q-3.
– Consumer Price Index (CPI)-based inflation projected to remain at
8% by Jan 2015 and 6% by Jan 2016.
– Repo rate (short term lending rate) unchanged at 8%.
– Cash Reserve Ratio (CRR) unchanged at 4%.
– Statutory Liquidity Ratio (used for unlocking banking funds)
retained at 22%.
– The liquidity rate under Export Credit Refinance (ECR) reduced
from 32% to 15% (w.e.f. 10 October 2014).

21. International Capital Market

22. International Capital Markets
• International capital markets are a group of markets (in
London, Tokyo, New York, Singapore, and other financial cities)
that trade different types of financial and physical capital
(assets), including
– stocks
– bonds (government and corporate)
– bank deposits denominated in different currencies
– commodities (like petroleum, wheat, bauxite, gold)
– forward contracts, futures contracts, swaps, options contracts
– real estate and land
– factories and equipment

23. Gains from Trade
• How have international capital markets increased the gains
from trade?
• When a buyer and a seller engage in a voluntary transaction,
both receive something that they want and both can be made
better off.
• A buyer and seller can trade
– goods or services for other goods or services
– goods or services for assets
– assets for assets

24. Gains from Trade Cont…

25. Gains from Trade
• The theory of comparative advantage describes the
gains from trade of goods and services for other
goods and services:
– with a finite amount of resources and time, use those
resources and time to produce what you are most
productive at (compared to alternatives), then trade those
products for goods and services that you want.
– be a specialist in production, while enjoying many goods
and services as a consumer through trade.

26. Cont…
• The theory of inter-temporal trade describes the gains from
trade of goods and services for assets, of goods and services
today for claims to goods and services in the future (today’s
assets).
– Savers want to buy assets (future goods and services)
and borrowers want to use assets (wealth) to consume or invest in
more goods and services than they can buy with current income.
– Savers earn a rate of return on their assets, while borrowers are able
to use goods and services when they want to use them: they both can
be made better off.

27. Cont…
• The theory of portfolio diversification describes the
gains from trade of assets for assets, of assets with
one type of risk with assets of another type of risk.
– Many times in economics (though not in Las Vegas) people
want to avoid risk: they would rather have a sure gain of
wealth than invest in risky assets.
– Economists say that investors often display risk aversion:
they are averse to risk.
– Diversifying or “mixing up” a portfolio of assets is a way for
investors to avoid or reduce risk.

28. Portfolio Diversification
• With portfolio diversification, both countries could always
enjoy a moderate potato yield and not experience the
vicissitudes of feast and famine.
– If the domestic country’s yield is 20 and the foreign country’s yield is
100 then both countries receive:
50%*20 + 50%*100 = 60.
– If the domestic country’s yield is 100 and the foreign country’s yield is
20 then both countries receive:
50%*100 + 50%*20 = 60.
– If both countries are risk averse, then both countries could be made
better off through portfolio diversification.

29. Classification of Assets
Claims on assets (“instruments”) are classified as either
1. Debt instruments
Examples include bonds and bank deposits
They specify that the issuer of the instrument must repay
a fixed value regardless of economic circumstances.
2. Equity instruments
Examples include stocks or a title to real estate
They specify ownership (equity = ownership) of variable profits or
returns, which vary according to economic conditions.

30. International Capital Markets
The participants:
1. Commercial banks and other depository
institutions:
– accept deposits
– lend to governments, corporations, other banks, and/or
individuals
– buy and sell bonds and other assets
– Some commercial banks underwrite stocks and bonds by
agreeing to find buyers for those assets at a specified
price.

31. Cont…
2. Non bank financial institutions: pension funds, insurance
companies, mutual funds, investment banks
– Pension funds accept funds from workers and invest them until the
workers retire.
– Insurance companies accept premiums from policy holders and
invest them until an accident or another unexpected event occurs.
– Mutual funds accept funds from investors and invest them in a
diversified portfolio of stocks.
– Investment banks specialize in underwriting stocks and bonds and
perform various types of investments.

32. Cont..
3. Private firms:
– Corporations may issue stock, may issue bonds or may borrow from
commercial banks or other lenders to acquire funds for investment
purposes.
– Other private firms may issue bonds or borrow from commercial
banks.
4. Central banks and government agencies:
– Central banks sometimes intervene in foreign exchange markets.
– Government agencies issue bonds to acquire funds, and may borrow
from commercial or investment banks.

33. Cont…
• Because of international capital markets, policy
makers generally have a choice of 2 of the
following 3 policies:
1. A fixed exchange rate
2. Monetary policy aimed at achieving domestic
economic goals
3. Free international flows of financial capital

34. Cont…
• A fixed exchange rate and an independent monetary policy
can exist if restrictions on flows of financial capital prevent
speculation and capital flight.
• Independent monetary policy and free flows of financial
capital can exist when the exchange rate fluctuates.
• A fixed exchange rate and free flows of financial capital can
exist if the central bank gives up its domestic goals and
maintains the fixed exchange rate.

35. Introduction to Credit Rating
Agencies

36. Credit Rating
• A credit rating estimates the credit worthiness of an a financial
security, a corporation, local government or even a country.
• It is an evaluation made by credit reporting agency of a risk of
buying into a specific security offering and based on a number
of factors.
• Credit ratings are calculated from financial history and current
assets and liabilities.
• Typically, a credit rating tells a lender or investor the
probability of the subject being able to meet payment
requirements for interest and principal repayment.

37. What is a credit rating?
• An opinion on the issuer's capacity to meet its financial
obligations on a particular issue in a timely manner, for
example long-term bonds:

38. Credit Rating Agency
A Credit Rating Agency (CRA) is a company that
is responsible for assessing the financial
strength of a company or government entity.
This includes domestic and foreign companies.
The main area that a credit rating agency
focuses on is the ability of the company or
government entity to meet the interest and
principle payments on their debts and bonds.

39. Functions of Credit Rating Agency
• Provide easy to understand information: Rating agencies gather
information, then analyze information to interpret and summarize
complex information in a simple and readily understood manner.
• Provide basis for investment: An investment rated by a credit rating
enjoys higher confidence from investors. Investors can make an
estimate of the risk and return associated with a particular rated issue
while investing money in them.
• Healthy discipline on corporate borrowers: Higher credit rating to
any credit investment makes the financial instrument (bond, mortgage
security) more attractive to investors. Corporations can borrow money
more cheaply if they maintain high credit ratings on their debt.
• Formation of public policy: Once the debt securities are rated
professionally, it would be easier to formulate public policy guidelines
as to the eligibility of securities to be included in different kinds of
institutional portfolios.

40. How ratings are established?

41. Rating Agencies
• International:
– Moody’s Investment Services
– Standard and Poor’s
– Fitch Rating
• National
– Fitch Ratings
– CRISIL (
– CIBIL (Credit Information Bureau (India) Limited)

42. Rating Scales used by Major Credit Raters

43. International Monetary System

44. International Monetary System
• International monetary systems are sets of
internationally agreed rules, conventions and
supporting institutions, that facilitate international
trade, cross border investment and generally there
allocation of capital between nation states.
• International monetary system refers to the
system prevailing in world foreign exchange
markets through which international trade and
capital movement are financed and exchange rates
are determined.

45. Cont..
• The International Monetary System is part of
the institutional framework that binds
national economies, such a system permits
producers to specialize in those goods for
which they have a comparative advantage,
and serves to seek profitable investment
opportunities on a global basis.

46. Features that IMS should possess
• Flow of international trade and investment
according to comparative advantage.
• Stability in foreign exchange and should be
stable.
• Promoting Balance of Payments adjustments to
prevent disruptions associated with temporary
or chronic imbalances.
• Providing countries with sufficient liquidity to
finance temporary balance of payments
deficits.

47. • Should at least try avoid adding further
uncertainty.
• Allowing member countries to pursue
independent monetary and fiscal policies.

48. Stages in IMS
• Classic Gold Standard (1816 – 1914)
• Interwar Period (1918 – 1939)
• Bretton Woods System (1944 – 1971)
• Present International Monetary System (1971

49. Classical Gold Standard
(1816 – 1914)

50. Classical Gold Standard
• 22nd June 1816, Great Britain declared the gold
currency as official national currency (Lord Liverpool’s
Act). On 1st May 1821 the convertibility of Pound
Sterling into gold was legally guaranteed.
• Other countries pegged their currencies to the British
Pound, which made it a reserve currency. This
happened while the British more and more dominated
international finance and trade relations.
• At the end of the 19th century, the Pound was used for
two thirds of world trade and most foreign exchange
reserves were held in this currency.

51. • Between 1810 and 1833 the United States had
de facto the silver standard. In 1834 (Coinage
Act of 1834), the government set the gold-silver
exchange rate to 16:1 which implemented a de
facto gold standard.
• In 1879 the United States set the gold price to
US$ 20,67 and returned to the gold standard.
With the “Gold Standard Act” of 1900, gold
became an official instrument of payment.

52. • From the 1870s to the outbreak of World War I in
1914, the world benefited from a well integrated
financial order, sometimes known as the First age
of Globalization. Money unions were operating
which effectively allowed members to accept
each others currency as legal tender including the
Latin Monetary Union and Scandinavian
monetary union
• In the absence of shared membership of a union,
transactions were facilitated by widespread
participation in the gold standard, by both
independent nations and their colonies

53. Rules of the System
• Each country defined the value of its currency
in terms of gold.
• Exchange rate between any two currencies
was calculated as X currency per ounce of
gold/ Y currency per ounce of gold.
• These exchange rates were set by arbitrage
depending on the transportation costs of gold.
• Central banks are restricted in not being able
to issue more currency than gold reserves.

54. Arguments in Favour of Gold Standard
• Price Stability:-
By tying the money supply to the supply of gold,
central banks are unable to expand the money
supply.
• Facilitates BOP adjustment automatically:-
The basic idea is that a country that runs a current
account deficit needs to export money (gold) to
the countries that run a surplus. The surplus of
gold reduces the deficit country’s money supply
and increases the surplus country’s money supply.

55. Arguments against Gold Standard
• The growth of output and the growth of gold
supplies needs to be closely linked. For example, if
the supply of gold increased faster than the supply
of goods did there would be inflationary pressure.
Conversely, if output increased faster than
supplies of gold did there would be deflationary
pressure.
• Volatility in the supply of gold could cause adverse
shocks to the economy, rapid changes in the
supply of gold would cause rapid changes in the
supply of money and cause wild fluctuations in
prices that could prove quite disruptive

56. • In practice monetary authorities may not be
forced to strictly tie their hands in limiting the
creation of money.
• Countries with respectable monetary policy
makers cannot use monetary policy to fight
domestic issues like unemployment.

57. Interwar Period (1918 – 1939)

58. Interwar Period
• The years between the world wars have been
described as a period of de-globalization, as both
international trade and capital flows shrank
compared to the period before World War I.
During World War I countries had abandoned the
gold standard and, except for the United States.
• The onset of the World Wars saw the end of the
gold standard as countries, other than the U.S.,
stopped making their currencies convertible and
started printing money to pay for war related
expenses.

59. • After the war, with high rates of inflation and a
large stock of outstanding money, a return to the
old gold standard was only possible through a
deep recession inducing monetary contraction as
practiced by the British afterWW I.
• The focus shifted from external cooperation to
internal reconstruction and events like the Great
Depression further illustrated the breakdown of
the international monetary system, bringing such
bad policy moves such as a deep monetary
contraction in the face of a recession.

60. Conditions Prior to Bretton Woods
• Prior to WW I major national currencies were on a
system of fixed exchange rates under the
international gold standards. This system had been
abandoned during WW I.
• There were fluctuating exchange rates from the
end of the War to 1925. But it collapsed with the
happening of the Great Depression.
• Many countries resorted to protectionism and
competitive devaluation. But depression
disappeared during WW II

61. BRETTON WOODS (1945-1971)
• British and American policy makers began to plan
the post war international monetary system in the
early 1940s.
• The objective was to create an order that
combined the benefits of an integrated and
relatively liberal international system with the
freedom for governments to pursue domestic
policies aimed at promoting full employment and
social wellbeing.
• The principal architects of the new system, John
Maynard Keynes and Harry Dexter White

62. • Bretton Woods is a little town in New Hampshire,
famous mostly for good skiing. In July 1944, the
International Monetary and Financial Conference
organized by the U.N attempted to put together an
international financial system that eliminated the chaos
of the inter-war years.
• The terms of the agreement were negotiated by 44
nations, led by the U.S and Britain. The main hope of
creating a new financial system was to stabilize
exchange rates, provide capital for reconstruction from
the war and foment international cooperation.

63. Features of Bretton Woods System
• The features of the Bretton Woods system can be
described as a “gold-exchange” standard rather
than a “gold-standard”. The key difference was
that the dollar was the only currency that was
backed by and convertible into gold. (The rate
initially was $35 an ounce of gold
• Other countries would have an “adjustable peg”
basically, they were exchangeable at a fixed rate
against the dollar, although the rate could be
readjusted at certain times under certain
conditions.

64. • Each country was allowed to have a 1% band
around which their currency was allowed to
fluctuate around the fixed rate. Except on the
rare occasions when the par value was allowed
to be readjusted, countries would have to
intervene to ensure that the currency stayed in
the required band.
• The IMF was created with the specific goal of
being the multilateral body that monitored the
implementation of the Bretton Woods
agreement.

65. • Its role was to hold gold reserves and currency
reserves that were contributed by the member
countries and then lend this money out to other
nations that had difficulty meeting their obligations
under the agreement.
• The borrowing was classified into tranches, each
with attached conditions that became
progressively stricter. This enabled the IMF to force
countries to adjust excess fiscal deficits, tighten
monetary policy etc, and force them to be more
consistent with their obligations under the
agreement.

66. The Demise of the Bretton Woods System
• In the early post-war period, the U.S. government had to
provide dollar reserves to all countries who wanted to
intervene in their currency markets. Lead to problem of lack of
international liquidity.
• The increasing supply of dollars worldwide, made available
through programs like the Marshall Plan, meant that the
credibility of the gold backing of the dollar was in question. U.S.
dollars held abroad grew rapidly and this represented a claim
on U.S. gold stocks and cast some doubt on the U.S.’s ability to
convert dollars into gold upon request.