Prof. S. Maitra,iasstudymat.blogspot.com
What is Monetary Policy?  The term monetary policy refers to actions taken by   central banks to affect monetary magnitud...
Monetary Policy during recession At times of recession monetary    policy involves the adoption of    some monetary tools...
Monetary Policy during inflation    At the time of inflation    monetary policy seeks to    contract aggregate spending   ...
Three objectives To ensure the economic stability at full  employment or potential level of  output. To achieve price stab...
Tools of Monetary PolicyBank rate policyOpen market operationsChanging cash reserve ratioUndertaking selective credit cont...
Bank Rate Policy  Bank rate is the minimum rate at which the central   bank of a country provides loan to the commercial ...
Limitations Well organized money market  should exist in the economy. It  is not present in India It is useful during th...
Open Market Operations  It means the purchase and sale of   securities by central bank of the   country.  It is useful f...
Limitations  When the central bank purchases the securities the cash   reserve of member bank will be increased and vice ...
What is CRR?  CRR means Cash Reserve Ratio.  Banks in India are required to hold a certain proportion of their   deposit...
What is CRR?  Consequent upon amendment to RBI act in 2006, RBI can   prescribe Cash Reserve Ratio (CRR) for scheduled ba...
What is SLR?  Every bank is required to maintain at the close of    business every day, a minimum proportion of their    ...
Repo Rate  Repo (Repurchase) rate is the rate at     which the RBI lends shot-term money to     the banks against securit...
Reverse Repo Rate  Reverse Repo rate is the rate at which banks park     their short-term excess liquidity with the RBI. ...
Repo Rate signifies the rate at     which liquidity is injected in the     banking system by RBI, whereas     Reverse rep...
 The policy announcements on 03/05/2011,    indicates that now repo rate has become the only    independent variable poli...
Marginal Standing Facility  Under this scheme, Banks will be able     to borrow upto 1% of their respective     Net Deman...
Expansionary Monetary Policy  Problem: Recession and unemployment  Measures:  (1) Central bank buys securities through ...
Tight Monetary Policy  Problem: Inflation  Measures: (1) Central bank sells securities through open   market operation ...
Sources of Monetary Mismanagement Variable time lags concerning the  effect of money supply on the  national income. Tre...
Role of Monetary Policy inEconomic Growth  Monetary policy and savings.  Monetary policy and investment.  Cost of credi...
Monetary Policy of RBI  In recent years starting from the mid-nineties   promoting economic growth is being given greater...
Monetary Policy of ControlledExpansion  Reserve bank’s responsibility in the circumstances is   mainly to moderate the ex...
Monetary Policy in the preReform Period (1972—1991) Price situation worsened during  the years of 1972- 1974. to  contain...
Easy and Liberal MonetaryPolicy  Liberal monetary policy adopted for   encouraging private sector since   1996.  Two ins...
Repo Rate System  It is introduced through which RBI can add to   liquidity in the banking system. Through repo   system ...
Liquidity AdjustmentFacility(LAF)  It is the another instrument of monetary   policy from June 2000 to adjust on a daily ...
Movements in Key Policy Rates in India03/20/12   ICSA 2012 GS Indian Economics/Prof. S.Maitra   29
Latest Rates  Bank Rate  9.50% (w.e.f. close of business of 13/02/2012) .  Increased from 6.00% to 9.50% which was cont...
Latest Rates  Repo Rate under LAF  8.50% (w.e.f.25/10/2011)  Increased from 8.25% which was continuing since 16/09/2011...
Neutral interest rate  “Neutral interest rate”, as a concept, generally    refers to the level of interest rate at which ...
Neutral interest rate  The concept of natural rate of interest was first   introduced into economics by the Swedish   eco...
Neutral interest rate    Although natural and neutral rates of interest are    used interchangeably, there are major conce...
Liquidity Management Measures taken by the RBI                   in 2010--11 Event:  End-May 2010: Larger than   anticipa...
Liquidity Management Measurestaken by the RBI in 2010--11 Measures:  For the period May 28, 2010-July 2, 2010, SCBs were:...
Liquidity Management Measurestaken by the RBI in 2010--11 Event:  End-October 2010: Frictional liquidity    pressure due ...
Liquidity Management Measurestaken by the RBI in 2010--11 Measures:  (i)The Reserve Bank conducted special SLAF on Octobe...
Liquidity Management Measurestaken by the RBI in 2010--11  (iii) The Reserve Bank re-started purchase of   government sec...
Liquidity Management Measurestaken by the RBI in 2010--11 Event: Mid-December 2010:  Continued build up in  government ba...
Liquidity Management Measurestaken by the RBI in 2010--11 Measures:  In the mid-Quarter Review of December 2010, the   Re...
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ICSA Civil Services (Prelims) GS Indian Economics Exam 2012: Lecture 8 by Prof. S. Maitra (isastudymat.blogspot.com)

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  • CSA 2011 GS Induan Economics/Prof.S.Maitra
  • CSA 2011 GS Induan Economics/Prof.S.Maitra
  • ICSA Civil Services (Prelims) GS Indian Economics Exam 2012: Lecture 8 by Prof. S. Maitra (isastudymat.blogspot.com)

    1. 1. Prof. S. Maitra,iasstudymat.blogspot.com
    2. 2. What is Monetary Policy?  The term monetary policy refers to actions taken by central banks to affect monetary magnitudes or other financial conditions.  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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 2
    3. 3. Monetary Policy during recession 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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 3
    4. 4. Monetary Policy during inflation At the time of inflation monetary policy seeks to contract aggregate spending by tightening the money supply or raising the rate of return.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 4
    5. 5. Three 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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 5
    6. 6. Tools of Monetary PolicyBank rate policyOpen market operationsChanging cash reserve ratioUndertaking selective credit controls.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 6
    7. 7. 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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 7
    8. 8. Limitations Well organized money market should exist in the economy. It is not present in India It is useful during the times of inflation but it does not fullfil its purpose during the time of recession or depression.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 8
    9. 9. 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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 9
    10. 10. Limitations  When the central bank purchases the securities the cash reserve of member bank will be increased and vice 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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 10
    11. 11. What is CRR?  CRR means Cash Reserve Ratio.  Banks in India are required to hold a certain proportion of their deposits in the form of cash. However, actually Banks don’t hold these as cash with themselves, but deposit such cash with Reserve Bank of India (RBI). This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR or Cash Reserve Ratio.  Thus, When a bank’s deposits increase by Rs100, and if the cash reserve ratio is 6%, the banks will have to hold additional Rs 6 with RBI and Bank will be able to use only Rs 94 for investments and lending / credit purpose. Therefore, higher the ratio (i.e. CRR), the lower is the amount that banks will be able to use for lending and investment.  This power of RBI to reduce the lendable amount by increasing the CRR, makes it an instrument in the hands of a central bank through which it can control the amount that banks lend. Thus, it is a tool used by RBI to control liquidity in the banking system.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 11
    12. 12. What is CRR?  Consequent upon amendment to RBI act in 2006, RBI can prescribe Cash Reserve Ratio (CRR) for scheduled banks without any floor rate or ceiling rate ( Before this enactment, the Reserve Bank could prescribe CRR for scheduled banks between 3 per cent and 20 per cent of total of their demand and time liabilities).  RBI uses CRR either to drain excess liquidity or to release funds needed for the growth of the economy from time to time. Increase in CRR means that banks have less funds available and money is sucked out of circulation. Thus we can say that this serves duel purposes i.e.(a) ensures that a portion of bank deposits is kept with RBI and is totally risk-free, (b) enables RBI to control liquidity in the system, and thereby, inflation by tying the hands of the banks in lending money03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 12
    13. 13. What is SLR?  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). 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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 13
    14. 14. Repo Rate  Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to the banks against securities. 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 03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 14
    15. 15. Reverse Repo Rate  Reverse Repo rate is the rate at which banks park their short-term excess liquidity with the RBI. The banks use this tool when they feel that they are stuck with excess funds and are not able to invest anywhere for reasonable returns. An increase in the reverse repo rate means that the RBI is ready to borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep more and more surplus funds with RBI. 03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 15
    16. 16. 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 03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 16
    17. 17.  The policy announcements on 03/05/2011, indicates that now repo rate has become the only independent variable policy rate, marking a shift from earlier method of calibrating various policy rates separately. The reverse repo rate -- the rate at which RBI borrows – will be kept 100 basis points lower than the repo rate. On the other hand Marginal Standing Facility (MSF) rate will be kept 100 basis points higher than the repo rate.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 17
    18. 18. Marginal Standing Facility  Under this scheme, Banks will be able to borrow upto 1% of their respective Net Demand and Time Liabilities". The rate of interest on the amount accessed from this facility will be 100 basis points (i.e. 1%) above the repo rate. This scheme is likely to reduce volatility in the overnight rates and improve monetary transmission. This facility has become effective from May 9, 2011 03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 18
    19. 19. 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 investment03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 19
    20. 20. 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 falls03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 20
    21. 21. 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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 21
    22. 22. Role of Monetary Policy inEconomic Growth  Monetary policy and savings.  Monetary policy and investment.  Cost of credit.. i) Monetary policy and public investment. ii) Monetary policy and private investment. iii)Allocation of investment funds.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 22
    23. 23. 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 expansion(1951-1972). Monetary policy in the pre-reforms period(1972-1991) . Monetary policy in the post-reforms period(1991-2011).03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 23
    24. 24. Monetary Policy of ControlledExpansion  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 control03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 24
    25. 25. Monetary Policy in the preReform 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 policy03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 25
    26. 26. Easy and Liberal MonetaryPolicy  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 .03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 26
    27. 27. 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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 27
    28. 28. Liquidity AdjustmentFacility(LAF)  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.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 28
    29. 29. Movements in Key Policy Rates in India03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 29
    30. 30. Latest Rates  Bank Rate  9.50% (w.e.f. close of business of 13/02/2012) .  Increased from 6.00% to 9.50% which was continuing sinc   Cash Reserve Ratio (CRR)  5.50% (wef 28/01/2012) - announced on 24/01/2012 Decreased from 6.00% to 5.50% which was continuing sin  Statutory Liquidity Ratio (SLR)  24%(w.e.f. 18/12/2010) Decreased from 25% which was continuing since 07/11/20 03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 30
    31. 31. Latest Rates  Repo Rate under LAF  8.50% (w.e.f.25/10/2011)  Increased from 8.25% which was continuing since 16/09/2011   Reverse Repo Rate under LAF *  7.50% (w.e.f. 25/10/2011)  Increased from 7.25% which was continuing since 16/09/2011   *Reverse Report rate was an independent rate till 03/05/2011. Howeve03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 31
    32. 32. Neutral interest rate  “Neutral interest rate”, as a concept, generally refers to the level of interest rate at which monetary policy stance is neither expansionary nor contractionary. Policy stance can be deemed “neutral” when the real interest rate reaches a level that is consistent with full employment of resources over the medium-term, and hence full capacity output and price stability.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 32
    33. 33. Neutral interest rate  The concept of natural rate of interest was first introduced into economics by the Swedish economist Knut Wicksell in 1898. This rate, theoretically, essentially relates to:  (i) the rate of interest that equates saving with investment;  (ii) the marginal productivity of capital, and  (iii) the rate of interest that is consistent with aggregate price stability.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 33
    34. 34. Neutral interest rate Although natural and neutral rates of interest are used interchangeably, there are major conceptual differences between the two. Moreover, while the former emerges in the market and is not directly observable, the latter essentially is an empirical approximation used in practice for conduct of monetary policy. Thus, the neutral rate of interest is useful as an important benchmark for the actual conduct of monetary policy and also market analysis of monetary policy stance.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 34
    35. 35. Liquidity Management Measures taken by the RBI in 2010--11 Event:  End-May 2010: Larger than anticipated collection for 3G/ BWA spectrum in addition to advance tax outflow resulted in migration of liquidity to central government’s cash balance account with the Reserve Bank03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 35
    36. 36. Liquidity Management Measurestaken by the RBI in 2010--11 Measures:  For the period May 28, 2010-July 2, 2010, SCBs were:  (i) Allowed to avail additional liquidity support under the LAF to the extent of up to 0.5 per cent of their Net Demand and Time Liabilities NDTL (for any shortfall in maintenance of SLR arising out of availing of this facility, banks were allowed to seek waiver of penal interest).  (ii) Given access to second LAF (SLAF) on a daily basis.  With the persistence of deficit liquidity conditions, measure (i) was extended up to July 16, 2010 and  measure (ii) up to July 30, 2010.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 36
    37. 37. Liquidity Management Measurestaken by the RBI in 2010--11 Event:  End-October 2010: Frictional liquidity pressure due to autonomous factors compounded by banks’ high CRR requirement (since the fortnight ended October 22, 2010 had seen a large increase in NDTL)03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 37
    38. 38. Liquidity Management Measurestaken by the RBI in 2010--11 Measures:  (i)The Reserve Bank conducted special SLAF on October 29 and November 1, 2010, a special two day repo auction under the LAF on October 30, 2010, and allowed waiver of penal interest on shortfall in maintenance of SLR (on October 30-31, 2010) to the extent of 1.0 per cent of NDTL for availing additional liquidity support under the LAF.  (ii) The Reserve Bank extended these liquidity easing measures further and conducted SLAF on all days during November 1-4, 2010 and extended the period of waiver of penal interest on shortfall  in maintenance of SLR ( to the extent of 1.0 per cent of NDTL) for availing additional liquidity support under the LAF till November 7, 2010.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 38
    39. 39. Liquidity Management Measurestaken by the RBI in 2010--11  (iii) The Reserve Bank re-started purchase of government securities under its open market operations (OMO) from November 4, 2010.  (iv) On November 9, 2010, the Reserve Bank reintroduced daily SLAF and extended the period of waiver of penal interest on shortfall in maintenance of SLR to the extent of 1.0 per cent of NDTLfor availing additional liquidity support under the LAF till December 16, 2010.  (v) On November 29, 2010, the Reserve Bank extended the daily SLAF and allowed additional liquidity support to the SCBs under the LAF to the extent of up to 2.0 per cent of their NDTL till January 28, 2011.03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 39
    40. 40. Liquidity Management Measurestaken by the RBI in 2010--11 Event: Mid-December 2010: Continued build up in government balances on account of third quarterly advance tax collections03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 40
    41. 41. Liquidity Management Measurestaken by the RBI in 2010--11 Measures:  In the mid-Quarter Review of December 2010, the Reserve Bank:  (i) Reduced the SLR of SCBs from 25 per cent of NDTL to 24 per cent with effect from December 18, 2010. Given the permanent reduction in the SLR, additional liquidity support of 1.0 per cent of NDTL under the LAF would be available from December 18, 2010 till January 28, 2011.  (ii) Announced conduct of OMO auctions for purchase of government securities for an aggregate amount of Rs.48,000 crore in the next one month (staggered as purchases of Rs.12,000 crore per week).03/20/12 ICSA 2012 GS Indian Economics/Prof. S.Maitra 41

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