MONETARY POLICY
Monetary policy is a tool with RBI to regulate the interest rate and money supply expansion that prevail in the economy. RBI is
vested with the powers for formulating, supervising and controlling the monetary and banking system.
Instruments: There are 2 categories of instrument of monetary policy.
(1) Under the general category, it has powers to conduct open market operations (OMO), change the
reserve ratios and alter the discount rates.
(2) Under special category it can have various credit direction program (priority sector, export credit, food credit
etc.) and specifying margins and level of credit in special categories (selective credit control).
Easy or tight money Policy :
(1) An easy money policy is intended to increase the money supply. It help bring about a reduction in interest rates. Lower
interest rates are expected to stimulate a sluggish economy. RBI buys securities from banks or reduces reserve ratio or the
bank rate. RBI usually follows an easy policy in times of recessions and economic slowdown.
(2) Tight policy is intended to cool down an overheated economy by limiting credit availability or making it very costly. For
this, RBI employs measures which would reduce the overall money supply, which basically are the reverse of what is
adopted for an easy money policy. A tight money policy is implemented when economy suffers from inflationary pressures.
Open market operations : It refers to buying and selling of govt. securities by RBI in the open market. By its impact on the
reserves of banks, OMO helps control the money supply in the economy. When RBI sells Govt. securities to banks, the lendable
resources of the banks are reduced and banks are forced to reduce or contain their lending, thus curbing the money supply. When
money supply is reduced, the consequent increase in the interest rates tends to limit spending and investment.
Varying Reserve Ratios: An increase in CRR or SLR would force banks to deploy a larger part of their lendable resources as
reserves. As banks reduce their market lending operations, consequent decline in money supply would increase interest rate. Bank
rate / Repo Rate : When these are increased, banks reduce their borrowing from RBI, which lowers their lendable resources. The
decline in money supply increases the interest rates. The opposite happens when RBI reduces these rates.
Of 3 kinds of general monetary instruments, OMO is more flexible and preferred. MONETARY & LIQUIDITY AGGREGATES
Money stock measures were introduced by RBI during 1970 and the working group under Y V Reddy suggested major changes in
the money stock measures, which gave its recommendations (during Dec 1997) and implemented during June 1998. The current
measures are monetary (M) and liquidity (L) aggregates.
Monetary Aggregates
M 0 (called reserve money) = Currency in circulation + bankers’ deposits with RBI + other deposits with RBI (including primary
dealers’ balance) (there is weekly report).
M 1 (called Narrow money) = currency with public + current deposits with banking system + 15% of demand liabilities portion of
saving deposits with banking system + other deposits with RBI. (fortnightly report).
M 2 = M 1 + time liabilities portion (i.e. remaining 85%) of saving deposits with banking system + certificates of deposits issued
by banks + term deposits (excluding FCNR-B deposits) with a contractual maturity of up to and including one year with banking
system (fortnightly report).
M 3 (Called Broad money) = M 2 + term deposits (excluding FCNR-B) with a contractual maturity of over one year with the
banking system + call borrowings from non-depository financial corporations by the banking system. (fortnightly report)
Important points regarding monetary aggregates:
1.M0 is essentially the monetary base, compiled from the balance sheet of RBI.
2. M1 purely reflects the non-interest bearing monetary liabilities of banking system.
3. M 2, besides currency and current deposits, includes saving and short term deposits reflecting the transactions balances of
entities.
4. M3 has been redefined to reflect, in addition to M2, the call funding that the banking systems obtains from other financial
institutions.
Liquidity Aggregates
L I = M 3 + all deposits with post office saving banks (excluding NSCs)
L 2 = L 1 + term deposits with term lending institutions and refinancing institutions (FIs) + term borrowing by FIs + certificate of
deposits issued by FIs and L 3 = L 2 + public deposits of NBFCs.
Monetary policy is a tool with RBI to regulate the interest rate and money supply expansion that prevail in the economy. RBI is
vested with the powers for formulating, supervising and controlling the monetary and banking system.
Instruments: There are 2 categories of instrument of monetary policy.
(1) Under the general category, it has powers to conduct open market operations (OMO), change the
reserve ratios and alter the discount rates.
(2) Under special category it can have various credit direction program (priority sector, export credit, food credit
etc.) and specifying margins and level of credit in special categories (selective credit control).
Easy or tight money Policy :
(1) An easy money policy is intended to increase the money supply. It help bring about a reduction in interest rates. Lower
interest rates are expected to stimulate a sluggish economy. RBI buys securities from banks or reduces reserve ratio or the
bank rate. RBI usually follows an easy policy in times of recessions and economic slowdown.
(2) Tight policy is intended to cool down an overheated economy by limiting credit availability or making it very costly. For
this, RBI employs measures which would reduce the overall money supply, which basically are the reverse of what is
adopted for an easy money policy. A tight money policy is implemented when economy suffers from inflationary pressures.
Open market operations : It refers to buying and selling of govt. securities by RBI in the open market. By its impact on the
reserves of banks, OMO helps control the money supply in the economy. When RBI sells Govt. securities to banks, the lendable
resources of the banks are reduced and banks are forced to reduce or contain their lending, thus curbing the money supply. When
money supply is reduced, the consequent increase in the interest rates tends to limit spending and investment.
Varying Reserve Ratios: An increase in CRR or SLR would force banks to deploy a larger part of their lendable resources as
reserves. As banks reduce their market lending operations, consequent decline in money supply would increase interest rate. Bank
rate / Repo Rate : When these are increased, banks reduce their borrowing from RBI, which lowers their lendable resources. The
decline in money supply increases the interest rates. The opposite happens when RBI reduces these rates.
Of 3 kinds of general monetary instruments, OMO is more flexible and preferred. MONETARY & LIQUIDITY AGGREGATES
Money stock measures were introduced by RBI during 1970 and the working group under Y V Reddy suggested major changes in
the money stock measures, which gave its recommendations (during Dec 1997) and implemented during June 1998. The current
measures are monetary (M) and liquidity (L) aggregates.
Monetary Aggregates
M 0 (called reserve money) = Currency in circulation + bankers’ deposits with RBI + other deposits with RBI (including primary
dealers’ balance) (there is weekly report).
M 1 (called Narrow money) = currency with public + current deposits with banking system + 15% of demand liabilities portion of
saving deposits with banking system + other deposits with RBI. (fortnightly report).
M 2 = M 1 + time liabilities portion (i.e. remaining 85%) of saving deposits with banking system + certificates of deposits issued
by banks + term deposits (excluding FCNR-B deposits) with a contractual maturity of up to and including one year with banking
system (fortnightly report).
M 3 (Called Broad money) = M 2 + term deposits (excluding FCNR-B) with a contractual maturity of over one year with the
banking system + call borrowings from non-depository financial corporations by the banking system. (fortnightly report)
Important points regarding monetary aggregates:
1.M0 is essentially the monetary base, compiled from the balance sheet of RBI.
2. M1 purely reflects the non-interest bearing monetary liabilities of banking system.
3. M 2, besides currency and current deposits, includes saving and short term deposits reflecting the transactions balances of
entities.
4. M3 has been redefined to reflect, in addition to M2, the call funding that the banking systems obtains from other financial
institutions.
Liquidity Aggregates
L I = M 3 + all deposits with post office saving banks (excluding NSCs)
L 2 = L 1 + term deposits with term lending institutions and refinancing institutions (FIs) + term borrowing by FIs + certificate of
deposits issued by FIs and L 3 = L 2 + public deposits of NBFCs.
No comments:
Post a Comment