Session 3

Monetary Policy

Presented on – 16 August, 2018

By – Kaustubhi Shukla
Manisha Bhanker
Sujit Kumar
 Monetary policy
• Monetary policy refers to how central
banks manage liquidity to create
economic growth.
• It often targets an inflation rate or
interest rate to ensure price stability and
general trust in the currency
• Liquidity implies the availability of liquid
assets to a market or company i.e quick
purchase of an asset without causing a
drastic change in the assets price.
• That includes credit, cash, cheques, and
some money market mutual funds.
• The most important of these is credit. It
includes loans, bonds and mortgages.

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Types of Monetary Policy
• Contractionary Monetary Policy - Central
banks use contractionary monetary policy
to reduce inflation. They have many tools
to do this. The most common are raising
interest rates and selling securities
through open market operations.

• Expansionary Monetary Policy -

Expansionary monetary policy is used as a
tool to lower unemployment and avoid
recession. They lower interest rates, buy
securities from member banks, and use
other tools to increase liquidity.

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Functions of Monetary Policy
 Strategic Goal - Conduct monetary policy that promotes the achievement of the Federal Reserve's statutory
objectives of maximum employment and stable prices.
 Objectives
• Monetary policy can be of great use in these economies for effecting necessary adjustment between the
demand for and supply of money.
• It can be more useful in influencing the pattern of investment and production by controlling the provision of
credit by banks.
• It can help in the expansion of financial institutions by granting subsidies and special facilities to new
institutions and provision of training facilities for their staff.
• Monetary policy can be made use of to stop borrowing for speculative purposes and to divert them for
productive purposes.
• Monetary policy can also help growth. The sectorial impacts of such policy in a developing economy are worth
noting
• Monetary policy in a developing economy should also be concerned with the balance of payments problem.

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Determinants of Money Supply
• There are two theories of the determination of the money supply. According to the first view, the
money supply is determined exogenously by the central bank. The second view holds that the money
supply is determined endogenously by changes in the economic activity which affects people’s desire
to hold currency relative to deposits, the rate of interest, etc.
• Thus the determinants of money supply are both exogenous and endogenous which can be
described broadly as: the minimum cash reserve ratio, the level of bank reserves, and the desire of
the people to hold currency relative to deposits. The last two determinants together are called the
monetary base or the high powered money.
The 4 determinants are-
• The Required Reserve Ratio
• The Level of Bank Reserves
• Public’s Desire to Hold Currency and Deposits
• Other Factors; eg- changes in business factors or emergency situations

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 What are ‘OMO’ ?
• Open market operations (OMO)
refer to the buying and selling of
government securities in the
open market in order to expand
or contract the amount of
money in the banking system.
Securities' purchases inject
money into the banking system
and stimulate growth, while
sales of securities do the
opposite and contract the
economy.

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Cash reserve Ratio (CRR)
• Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with the RBI.
If the central bank decides to increase the CRR, the available amount with the banks
comes down. The RBI uses the CRR to drain out excessive money from the system.

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Statutory liquidity ratio (SLR)
• Statutory liquidity ratio (SLR) is the Indian government term for the reserve requirement
that the commercial banks in India are required to maintain in the form of cash, gold
reserves, government approved securities before providing credit to the customers.

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 Bank rate - Repo rate - Reverse repo rate
• Bank rate, also referred to as the discount rate in American English, is the rate of interest which a
central bank charges on its loans and advances to a commercial bank.

• Repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of
India) lends short term money to commercial banks in the event of any shortfall of funds against
securities. Repo rate is used by monetary authorities to control inflation.

• Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case
of India) borrows money from commercial banks within the country. It is a monetary policy
instrument which can be used to control the money supply in the country.
• Any hike in Bank rate, Repo rate or Reverse Repo rate leads to rise in interest rate in the economy
and vice versa.
• The Reserve Bank of India increased the Repo Rate again on the 1st of August 2018
from 6.25% to 6.50%. Even the reverse repo rate was increased to 6.25%from 6%.

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 Indicator Current rate
CRR 4%
SLR 19.5%
Repo rate 6.50%
Reverse repo rate 6.25%

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 References

• https://www.thebalance.com/what-is-monetary-policy-objectives-types-and-tools-3305867
• https://www.federalreserve.gov/publications/gpra/2011-monetary-policy-function.htm
• https://economictimes.indiatimes.com/definition/repo-rate
• https://economictimes.indiatimes.com/definition/reverse-repo-rate
• https://qph.fs.quoracdn.net/main-qimg-9ca5c108bfbdfd64d869104094d52fe7
• http://www.yourarticlelibrary.com/economics/money/money-supply-determinants-of-money-
supply-and-high-powered-money-and-money-multiplier/10971

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