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MONETARY POLICY
Dr. Raj Agrawal
INTRODUCTION
•To regulate the supply of money.
•To regulate cost & availability of credit.
•To understand objectives, targets & instrument.
•Goals of monetary policy refer to its objective.
OBJECTIVES
• Ensuring price stability - Better suited to
control the inflation rate.
• Economic growth – Promotes economic
growth ensuring availability of credit.
• Exchange rate stability – Exchange rate of
rupee by demand & supply is determined by
demand for & supply of foreign exchange.
ESSENTIAL FUNCTIONS OF MONEY
 Medium of Exchange: Hence permits a time interval
between buying & selling commodities.
 Store of Value: Able to perform function as Medium of
Exchange because it retains value over time.
 Standard of Deferred Payment: Loans & future
payments are agreed & contracted in money terms.
 Unit of Account: the unit of account in which prices
quoted and accounting records kept.
FINANCIAL SYSTEM OF INDIA
• Financial system is regulated by independent regulators in
the sectors of banking, insurance, capital markets,
competition and various services sectors. In a number of
sectors Government plays the role of regulator.
• RBI(established in 1935)is regulator for financial and
banking system, formulates monetary policy and prescribes
exchange control norms.
• India has a two-tier structure of financial institutions with
thirteen all India financial institutions and forty-six
institutions at the state level.
BANKING TERMS
CASH RESERVE RATIO(CRR): Cash Reserve Ratio is a bank
regulation that sets the minimum reserves each bank must
hold to customer deposits and notes with the Reserve Bank of
India.
 The higher the CRR required , the lower the money available
for lending.
 If the government wants to stimulate higher economic activity
and encourage higher spending to achieve economic growth ,
they will lower CRR.
STATUTORY LIQUIDITY RATIO(SLR): Statutory liquidity ratio
is the statutory reserve that is set aside by banks for
investment in cash , gold or government approved securities
valued at a price not exceeding the current market price.
 Any reduction in the SLR level increases the amount of money
available with banks for lending to individuals, companies or
other banks. Any hike in the SLR has the opposite effect.
REPO RATE: Repo rate is the rate at which our banks borrow
rupees from RBI.
 A reduction in the repo rate will help banks to get money at a
cheaper rate. When the repo rate increases borrowing from
RBI becomes more expensive.
REVERSE REPO RATE: Reverse Repo rate is the rate at which
Reserve Bank of India (RBI) borrows money from banks.
 Banks are always happy to lend money to RBI since their
money are in safe hands with a good interest.
MONEY MULTIPLIER
• Mathematical
relationship
between
the
monetary base and money supply of an economy.
• Explains the increase in the amount of cash in
circulation by the banks ability to lend out of
their depositor’s funds.
• It calculates the maximum amount of money that
an initial deposit can be expanded to with a given
reserve ratio.
HOW IT WORKS
• RM is the base money created by the RBI
whenever it mops up foreign exchange from
the market or lends to the Government and
banks against purchase of securities.
• This primary rupee liquidity gets incorporated
into the system either as currency with the
public or as additional cash with banks.
HOW IT WORKS
• The surplus cash (over and above their reserve
requirement) is lent out by banks to the
public.
• The end-result is that every unit of `base'
money generates multiple units of `broad
money' through successive rounds of depositcum-credit creation
DEMAND FOR FUNDS
• The same base money ended up circulating
more number of times to cater to the broad
money requirement of a resurgent economy.
• To the extent this additional money does not
go out to borrowers and gets successively redeposited or re-lent, it weakens the money
multiplier.
THE MYTH
• The money multiplier concept implicitly assumes
that the Fed controls the money supply by setting
the required reserve ratio, and then issuing
enough reserves to enable aggregate bank
lending to a multiple of that ratio.
• The money multiplier concept represents a
misunderstanding about how the credit money
supply grows.
CURRENT SCENARIO RBI
(2008-09)
Confidence and return to normal functioning.
The Reserve Bank has reviewed the current and
evolving macroeconomic situation and liquidity
conditions.
On October 20, 2008, the Reserve Bank
announced a reduction in the repo rate from 9.0
to 8.0 per cent.
• Maintaining price stability and sustaining the
growth momentum.
• If sustained, would further reduce inflationary
pressures.
• Domestic financial markets have been functioning
normally.
• In order to provide further comfort on liquidity
and to impart flexibility in liquidity management
to banks.
The objective is to maintain appropriate liquidity in the
system such that all legitimate requirements of credit
are met, consistent with the objective of price and
financial stability.
The Reserve Bank will continue to closely monitor the
developments in the global and domestic financial
markets and will take swift and effective action as
appropriate.