monetary policynew

7/31/2019 Monetary Policynew

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List of Contents

What is Monetary policy?

History of Monetary policy

Goals/Objectives of Monetary Policy

Types of Monetary Policy

Instruments/Tools Of Monetary Policy

Quantitative & Qualitative Measures

Highlights of Monetary Policy 2010-2011

Limitations Of Monetary Policy

Effects of Monetary policy

Conclusion


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What is Monetary Policy?

Monetary policy is essentially a programme ofaction undertaken by the monetary authoritiesgenerally the central bank, to control and regulate

the supply of money with the public and the flow ofcredit with a view to achieving the objectives ofgeneral economic policy

Shaw defines monetary policy as Any consciousaction undertaken by the monetary authorities tochange the quantity, availability or cost.., ofmoney.


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History of monetary policy

Monetary policy is associated with theinterest rates and availability of credit.

Instruments of monetary policy have

included short-term interest and bankreserves

For many centuries there were only two

forms of monetary policy:1.Decisions about coin age,

2.Decisions to print paper money to create

credit


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TYPES OF MONETARY POLICY

1. Expansionary Policy:

In an expansionary policy the government increases the total money supply in theeconomy rapidly.

The expansionary policy is adopted to reduce unemployment in recession bylowering the interest rates ,In an expansionary policy.

Example:

If the Central Government pursues expansionary monetary policy by increasing thesupply of money then the nominal interest rate will fall, investment will rise,consumption will rise.

2. CONTRACTIONARY POLICY:

In contractionary policy the government raises the interest rates to fight inflation.The contractionary policy leads to

Decrease in the money supply. Contractionary policy can be implemented byrequiring banks to hold a higher

Proportion of their total assets in reserve by requiring a higher proportion of totalassets to be held as liquid cash, the

Central bank reduces the availability of loan able funds. This acts as a reduction inthe money supply.


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Cont..

Example:

if the Fed pursues contractionary monetarypolicy by decreasing the supply of money,

the nominal interest rate will rise,investment will fall, and consumption willfall.

Interest sensitive purchases are expensive

People save more and consume less Because the supply of money decreases,

people buy lesser goods and services.


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Instruments of Monetary Policy

SLR

QUANTITATIVE

CashReserve

Ratio

Bank rateOpen marketoperations Credit

Rationing

DirectControls

MoralSuasion

QUALITATIVE

Change inLendingmargins

SLR


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Quatitative Instruments

Open Market Operations (OMO): It means the purchase and sale of securities by

the central bank of the country. The OMO is the most powerful and widely used

tool of monetary control.

Bank Rate: Bank rate is the rate at which the central bank

rediscounts the bills of exchange presented by the

commercial banks. For practical purposes bank rate is the rate which

the central bank charges on the loans andadvances to the commercial banks.


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Qualitative Instruments

Credit Rationing:Under this two measures are adopted: Imposition of upper limits on the credit available to large industries

and firms. Charging a higher interest rate on bank loans beyond a certain

limit.

Change In Lending Margins:

The banks provide loans only upto a certain percentage of thevalue of the mortgaged property.

The gap between the value of the mortgaged property andamount advanced is called lending margin.


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The Cash Reserve Ratio (CRR):

Cash Reserve Ratio is the percentage of total deposits which

commercial banks are required to maintain in the form of cashreserve with the central bank.

Statutory Liquidity Requirement (SLR):

The SLR Is that proportion of the total deposits which commercialbanks are

required to maintain with them in the form of liquid assets (cashreserve, gold and govt. bonds) in addition to CRR.


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Moral Suasion: The moral suasion is a method of persuading and

convincing the commercial banks to advance credit inaccordance with the directive of the central bank in the

economic interest of the country.

Direct controls:

Where all other methods prove ineffective, themonetary, authorities resort to direct control measureswith clear directive to the banks carry out their lendingactivity in a specified manner.


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Highlights of Monetary Policy2010-2011 The Reserve Bank announces the following policy

measures:

The Bank Rate has been retained at 6.0 percent.

It has been decided to increase the repo rate from5.0 per cent to 5.25 per cent The reverse repo rate is increased from 3.5 per

cent to 3.75 per cent. It has been decided to increase the cash reserve

ratio (CRR) of scheduled banks by 25 basis pointsfrom 5.75 per cent to 6.0 per cent. The SLR is announced 25%.


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Limitations Of Monetary Policy

The time lag :

The first and the most important limitation in theeffective working of monetary policy is the timelag. i.e. time taken in chalking out the policy action,

its implementation and working time.

Problem in forecasting :

The formulation of an appropriate monetary policy

requires a reliable assessment of the magnitude ofthe problem-recession or inflation- as it helps indetermining the appropriate policy measures.


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Non-banking Financial Intermediaries: The structural change in the financial market has also

reduced the scope of effectiveness of monetary policy.

Under Development of money and capital markets : The effectiveness of monetary policy in less developed

countries is reduced considerably because of the

underdeveloped character of their capital and moneymarkets.


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The Monetary Policy Effect

The expenditures that are most likely to be affected by monetary policy are those financed to a

substantial extent by the use of credit.

It includes business investment , inventory investment, residential construction, consumer

purchases , electrical appliances, furniture and capital outlays by state and local governments.

The paper by Michael J. Hamburger surveys a number of econometric studies that have been

made of each of these categories of expenditures.

Residential construction and business investment in plant and equipment are significantly

affected by monetary policy also significant effects on consumer purchases on state and local

government expenditures.

A number of investigators have been unsuccessful in isolating any monetary influences.

We can conclude with two main polices they are :The extent that monetary influences affect the

various types of expenditures primarily through interest rates.

There are substantial time lags between changes in interest rates and the resulting changes in

expenditures, although the lags seem to vary somewhat from one category of expenditures to

another.


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Contd.

The results of this kind of investigation thus far can hardly be characterized asconclusive. In some cases, such as business investment in plant and equipment, inwhich a number of independent investigations have been carried out, the differentinvestigators have used somewhat different models.

While all of the recent studies indicate that monetary policy has significant effects oninvestment which operate with substantial lags, both the magnitude of the effect and the

length of the lag vary considerably from one study to another. Clearly, much furtherstudy will be needed before we can predict the effects of monetary policy with verymuch confidence.

The survey in the Hamburger paper, discussed above, relates to the initial impacts oninvestment-defined broadly to include not only business investment but investment byhouseholds in new homes and durable goods and capital outlays by state and localgovernments. In a concluding section, Hamburger discusses briefly some resultsobtained by computer simulations using two large econometric models of the U.S.economy.

These simulations provide estimates of the total effects on the economy of certainchanges in monetary policy, including not only the initial impacts but also the secondarymultiplier and accelerator effects. These simulations suggest that monetary policy hasimportant effects but that the bulk of these effects are felt only after a considerable

amount of time has elapsed following the initiation of a change in policy.


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conclusion

Thus, the Government through its Monetary Policy canaffect the levels of money supply in the market. When

the inflation in any economy rises it raises the interest

rates to suck excess liquidity in the system thereby

reducing the purchasing power by making the credits

available costlier whereas when unemployment rises the

government increases the money supply by lowering

the interest rates which ultimately leads to cheaper

loans being available which in turn generatesemployment opportunities in an economy.

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