1

ACKNOWLEDGEMENT
ANY ACCOMPLISHMENT REQUIRES THE EFFORT OF MANY PEOPLE
AND THIS WORK IS NO DIFFERENT.WE WOULD LIKE TO THANK
PROF.FATIMA FOR GIVING US AN OPPURTUNITY FOR DOING THE
PRIJECT TOGETHER AND FOR HELPING AND GUIDING US IN
COMPLETION OF THE PROJECT.

WE WOULD ALL THANKS OUR PARENTS AND FRIENDS WHO HAVE

SUPPORTED US AND HELPED US THE PROJECT AND CONSTANTLY
MOTIVATED US IN DOING THE PROJECTT. THIS WAS A NEW LEARNING
EXPERIENCE FOR US AND WILL DEFINILY HELP IN FUTURE.

REGARDLESS OF RHE SOURCE WE WISH TO EXPRESS OUR

GRATITUDE TO TJOSE WHO HAVE CONTRIBUTED TO THIS WORK EVEN
THOUGH ANONYMOUSLY.

DECLARATION
We the student of royal college of SYBMS 3rd
Semester hereby declare that we have completed

2
this project on 16th Aug in the Academic Year 2010-
2011. The information submitted is true and
original to the best for our knowledge.

PRESENTED BY

NAME OF STUDENTS ROLL NO.

PRATIKSHA 18

AFSHA RATANSI 19

RITIKA SHETTY 23

MOIZ 19

ARUN 23

INDEX
Sr TOPIC Pg.
No. No

3
1 Introduction 5
2 Monetary Policy And The 6
Economy
3 Implementation Of Monetary 8
Policy
4 Types Of Monetary Policy 12
5 Monetary Policy Tools 18
6 Objectives Of Monetary Policy 23
7 Goals Of Monetary Policy 25
8 Limitations Of Monetary 27
Policy
9 Monetary Aggregates 30
10 Monetary Policy Of India 32
11 The Australian Monetary 35
Policy
12 Monetary Policy Of China 39
13 Monetary Policy Of Singapore 44
14 Monetary Policy Of Japan 46
15 The United States Monetary 49
Policy
16 Conclusion 51

4
 INTRODUCTION
Monetary policy is the process by which the central
bank or monetary authority of a country controls the supply
of money, often targeting a rate of interest. Monetary policy
is usually used to attain a set of objectives oriented towards
the growth and stability of the economy. These goals usually
include stable prices and low unemployment. Monetary
theory provides insight into how to craft optimal monetary
policy.

Monetary policy is referred to as either being an

expansionary policy, or a contractionary policy, where an
expansionary policy
increases the total
supply of money in the
economy rapidly, and a
contractionary policy
decreases the total
money supply or
increases it only slowly.
Expansionary policy is
traditionally used to
combat unemployment in a recession by lowering interest
rates, while contractionary policy involves raising interest
rates to combat inflation.

Monetary policy is contrasted with fiscal policy, which

refers to government borrowing, spending and taxation. An
attempt to achieve broad economic goals by the regulation
of the supply of money.

5
 MONETARY POLICY AND THE
ECONOMY
Being one of the most influential government policies,
monetary policy aims at affecting the economy through the
Fed's management of money and interest rates. As generally
accepted concepts, the narrowest definition of money is M1,
which includes currency, checking account deposits, and
traveler's checks. Time deposits, savings deposits, money
market deposits, and other financial assets can be added to
M1 to define other monetary measures such as M2 and M3.
Interest rates are simply the costs of borrowing. The Fed
conducts monetary policy through reserves, which are the
portion of the deposits that banks and other depository
institutions are required to hold either as cash in their vaults,
called vault cash, or as deposits with their home FRBs.
Excess reserves are the reserves in excess of the amount
required. These additional funds can be transacted in the
reserves market (the federal funds market) to allow
overnight borrowing between depository institutions to meet
short-term needs in reserves. The rate at which such private
borrowings are charged is the federal funds rate.

Monetary policy is closely linked with the reserves

market. With its policy tools, the Fed can control the
reserves available in the market, affect the federal funds
rate, and subsequently trigger a chain of reactions that
influence other short-term interests rates, foreign-exchange
rates, long-term interest rates, and the amount of money
and credit in the economy. These changes will then bring
about adjustments in consumption, affect saving and
investment decisions, and eventually influence employment,
output, and prices.

6
How Monetary Policy Affects The
Economy
The initial link in the chain between monetary policy
and the economy is the market for balances held at the
Federal Reserve Banks. Depository institutions have
accounts at their Reserve Banks, and they actively trade
balances held in these accounts in the federal funds market
at an interest rate known as the federal funds rate. The
Federal Reserve exercises considerable control over the
federal funds rate through its influence over the supply of
and demand for balances at the Reserve Banks.
The FOMC sets the federal funds rate at a level it believes
will foster financial and monetary conditions consistent with
achieving its monetary policy objectives, and it adjusts that
target in line with evolving economic developments.

A change in the federal funds rate, or even a change in

expectations about the future level of the federal funds rate,
can set off a chain of events that will affect other short-term
interest rates, longer-term interest rates, the foreign
exchange value of the dollar, and stock prices. In turn,
changes in these variables will affect households’ and
businesses’ spending decisions, thereby affecting growth in
aggregate demand and the economy.

7
 IMPLEMENTATION OF
MONETARY POLICY
Since the early 1980s, the Fed has been relying on the
overnight federal funds rate as the guide to its position in
monetary policy. The Fed has at its disposal three major
monetary policy tools:

Reserve Requirements
Under the Monetary Control Act of 1980, all depository
institutions, including commercial banks, savings and loans,
and others, are subject to the same reserve requirements,
regardless of their Fed member status. As of March 1999,
the basic structure of reserve requirements is 3 percent for
all checkable deposits up to $46.5 million and 10 percent for
the amount above $46.5 million. No reserves are required
for time deposits (data from Federal Reserve Bank of
Minneapolis, 1999).

Reserve requirement affects the so-called multiple

money creation. Suppose, for example, the reserve
requirement ratio is 10 percent. A bank that receives a $100
deposit (bank 1) can lend out $90. Bank 1 can then issue a
$90 check to a borrower, who deposits it in bank 2, which
can then lend out $81. As it continues, the process will
eventually involve a total of $1,000 ($100 + $90 + $81 +
$72.9 … $1,000) in deposits. The initial deposit of $100 is
thus multiplied 10 times. With a lower (higher) ratio, the
multiple involved is larger (smaller), and more (less)
reserves can be created.

Reserve requirements are not used as often as the

other policy tools. Since funds grow in multiples, it is difficult
to administer small adjustments in reserves with this tool.
Also, banks always have the option of entering the federal
funds market for reserves, further limiting the role of reserve
requirements.

8
The Discount Rate
Banks may acquire loans through the "discount
window" at their home FRB. The most important credit
available through the window is the adjustment credit, which
helps depository institutions meet their short-term needs
against, for example, unexpected large withdrawals of
deposits. The interest rate charged on such loans is the
basic discount rate and is the focus of discount policy. A
lower-rate encourages more borrowing. Through money
creation, bank deposits increase and reserves increase. A
rate hike works in the opposite direction. However, since it is
more efficient to adjust reserves through open-market
operations (discussed below), the amount of discount
window lending has been unimportant, accounting for only a
small fraction of total reserves. Perhaps a more meaningful
function served by the discount rate is to signal the Fed's
stance on monetary policy, similar to the role of the federal
funds rate.

By law, each FRB sets its discount rate every two

weeks, subject to the approval of the Board of Governors.
However, the gradual nationalization of the credit market
over the years has resulted in a uniform discount rate. Its
adjustments have been dictated by the cyclical conditions in
the economy, and the frequency of adjustments has varied.
In the 1990s, for example, the Fed cut the rate seven times
—from 7 percent to 3 percent— during the recession from
December 1990 to July 1992. Later, from May 1994 to
February 1995, the rate was raised four times—from 3
percent to5.25 percent—to counter possible economic
overheating and inflation. In January 1996, the rate was
lowered to 5 percent and it stayed there for the next thirty-
two months, during which the U.S. economy experienced a
solid and consistent growth with only minor inflation. From
October to November 1998, the Fed cut the rate twice, first
to 4.75 percent and then to 4.5 percent, anticipating the

9
threat from the global financial crisis that had began in Asia
in mid-1997 (data from "United States Monetary Policy,"
1999).

Open-Market Operations
The most important and flexible tool of monetary
policy is open-market operations (i.e., trading U.S.
government securities in the open market). In 1997, the Fed
made $3.62 trillion of purchases and $3.58 trillion of sales of
Treasury securities (mostly short-term Treasury bills). As of
September 1998, the Fed held $458.13 billion of Treasury
securities, roughly 8.25 percent of the total Federal debt
outstanding

The FOMC directs open-market operations (and also

advises about reserve requirements and discount-rate
policies). The day-to-day operations are determined and
executed by the Domestic Trading Desk (the Desk) at the
FRB of New York. Since 1980, the FOMC has met regularly
eight times a year in Washington, D.C. At each of these
meetings, it votes on an intermeeting target federal funds
rate, based on the current and prospective conditions of the
economy. Until the next meeting, the Desk will manage
reserve conditions through open-market operations to
maintain the federal funds rate around the given target
level. When buying securities from a bank, the Fed makes
the payment by increasing the bank's reserves at the Fed.
More reserves will then be available in the federal funds
market and the federal funds rate falls. By selling securities
to a bank, the Fed receives payment in reserves from the
bank. Supply of reserves falls and the funds rate rises.

The Fed has two basic approaches in running open-

market operations. When a shortage or surplus in reserves is
likely to persist, the Fed may undertake outright purchases
or sales, creating a long-term impact on the supply of
reserves. However, many reserve movements are

10
temporary. The Fed can then take a defensive position and
engage in transactions that only impose temporary effects
on the level of reserves. A repurchase agreement (a repo)
allows the Fed to purchase securities with the agreement
that the seller will buy back them within a short time period,
sometimes overnight and mostly within seven days.

The repo creates a temporary increase in reserves,

which vanishes when the term expires. If the Fed wishes to
drain reserves temporarily from the banking system, it can
adopt a matched sale-purchase transaction (a reverse repo),
under which the buyer agrees to sell the securities back to
the Fed, usually in less than seven days.

11
 TYPES OF MONETARY
POLICY
In practice, all types of monetary policy involve
modifying the amount of base currency (M0) in circulation.
This process of changing the liquidity of base currency
through the open sales and purchases of (government-
issued) debt and credit instruments is called open market
operations. Constant market transactions by the monetary
authority modify the supply of currency and this impacts
other market variables such as short term interest rates and
the exchange rate.

The distinction between the various types of monetary

policy lies primarily with the set of instruments and target
variables that are used by the monetary authority to achieve
their goals.

Target Market
Monetary Policy: Long Term Objective:
Variable:
Interest rate on A given rate of change in the
Inflation Targeting
overnight debt CPI
Price Level Interest rate on
A specific CPI number
Targeting overnight debt
Monetary The growth in money A given rate of change in the
Aggregates supply CPI
Fixed Exchange The spot price of the
The spot price of the currency
Rate currency
Low inflation as measured by
Gold Standard The spot price of gold
the gold price
Usually unemployment + CPI
Mixed Policy Usually interest rates
change

12
 The different types of policy are also called monetary
regimes, in parallel to exchange rate regimes. A fixed
exchange rate is also an exchange rate regime; The Gold
standard results in a relatively fixed regime towards the
currency of other countries on the gold standard and a
floating regime towards those that are not. Targeting
inflation, the price level or other monetary aggregates
implies floating exchange rate unless the management of
the relevant foreign currencies is tracking the exact same
variables (such as a harmonized consumer price index).

Inflation Targeting:
Under this policy approach the target is to keep
inflation, under a particular definition such as Consumer
Price Index, within a desired range.

The inflation target is achieved through periodic

adjustments to the Central Bank interest rate target. The
interest rate used is generally the interbank rate at which
banks lend to each other overnight for cash flow purposes.
Depending on the country this particular interest rate might
be called the cash rate or something similar.

The interest rate target is maintained for a specific

duration using open market operations. Typically the
duration that the interest rate target is kept constant will
vary between months and years. This interest rate target is
usually reviewed on a monthly or quarterly basis by a policy
committee.

Changes to the interest rate target are made in

response to various market indicators in an attempt to
forecast economic trends and in so doing keep the market
on track towards achieving the defined inflation target. For
example, one simple method of inflation targeting called the
Taylor rule adjusts the interest rate in response to changes
in the inflation rate and the output gap. The rule was
proposed by John B. Taylor of Stanford University.

13
 The inflation targeting approach to monetary policy
approach was pioneered in New Zealand. It is currently used
in Australia, Brazil, Canada, Chile, Colombia, the Eurozone,
New Zealand, Norway, Iceland, Philippines, Poland, Sweden,
South Africa, Turkey, and the United Kingdom.

Price Level Targeting:

Price level targeting is similar to inflation targeting except
that CPI growth in one year is offset in subsequent years
such that over time the price level on aggregate does not
move.

Monetary Aggregates:
In the 1980s, several countries used an approach based
on a constant growth in the money supply. This approach
was refined to include different classes of money and credit
(M0, M1 etc). In the USA this approach to monetary policy
was discontinued with the selection of Alan Greenspan as
Fed Chairman. This approach is also sometimes called
monetarism.

While most monetary policy focuses on a price signal of

one form or another, this approach is focused on monetary
quantities.

Fixed Exchange Rate:

14
 This policy is based on maintaining a fixed exchange
rate with a foreign currency. There are varying degrees of
fixed exchange rates, which can be ranked in relation to how
rigid the fixed exchange rate is with the anchor nation.

Under a system of fiat fixed rates, the local government

or monetary authority declares a fixed exchange rate but
does not actively buy or sell currency to maintain the rate.
Instead, the rate is enforced by non-convertibility measures
(e.g. capital controls, import/export licenses, etc.). In this
case there is a black market exchange rate where the
currency trades at its market/unofficial rate.

Under a system of fixed-convertibility, currency is

bought and sold by the central bank or monetary authority
on a daily basis to achieve the target exchange rate. This
target rate may be a fixed level or a fixed band within which
the exchange rate may fluctuate until the monetary
authority intervenes to buy or sell as necessary to maintain
the exchange rate within the band. (In this case, the fixed
exchange rate with a fixed level can be seen as a special
case of the fixed exchange rate with bands where the bands
are set to zero.)

Under a system of fixed exchange rates maintained by

a currency board every unit of local currency must be
backed by a unit of foreign currency (correcting for the
exchange rate). This ensures that the local monetary base
does not inflate without being backed by hard currency and
eliminates any worries about a run on the local currency by
those wishing to convert the local currency to the hard
(anchor) currency.

Under dollarization, foreign currency (usually the US

dollar, hence the term "dollarization") is used freely as the
medium of exchange either exclusively or in parallel with
local currency. This outcome can come about because the
local population has lost all faith in the local currency, or it
may also be a policy of the government (usually to rein in
inflation and import credible monetary policy).

15
 These policies often abdicate monetary policy to the
foreign monetary authority or government as monetary
policy in the pegging nation must align with monetary policy
in the anchor nation to maintain the exchange rate. The
degree to which local monetary policy becomes dependent
on the anchor nation depends on factors such as capital
mobility, openness, credit channels and other economic
factors.

Gold Standard:
The gold standard is a system in which the price of the
national currency is measured in units of gold bars and is
kept constant by the daily buying and selling of base
currency to other countries and nationals. (i.e. open market
operations, cf. above). The selling of gold is very important
for economic growth and stability.

The gold standard might be regarded as a special case

of the "Fixed Exchange Rate" policy. And the gold price
might be regarded as a special type of "Commodity Price
Index".

Today this type of monetary policy is not used

anywhere in the world, although a form of gold standard was
used widely across the world between the mid-1800s
through 1971. Its major advantages were simplicity and
transparency.

The major disadvantage of a gold standard is that it

induces deflation, which occurs whenever economies grow
faster than the gold supply. When an economy grows faster
than its money supply, the same amount of money is used
to execute a larger number of transactions. The only way to

16
make this possible is to lower the nominal cost of each
transaction, which means that prices of goods and services
fall, and each unit of money increases in value.

Deflation can cause economic problems, for instance, it

tends to increase the ratio of debts to assets over time. As
an example, the monthly cost of a fixed-rate home mortgage
stays the same, but the dollar value of the house goes down,
and the value of the dollars required to pay the mortgage
goes up. William Jennings Bryan rose to national prominence
when he built his historic (though unsuccessful) 1896
presidential campaign around the argument that deflation
caused by the gold standard made it harder for everyday
citizens to start new businesses, expand their farms, or build
new homes.

Policy Of Various Nations:

• Australia - Inflation targeting
• Brazil - Inflation targeting
• Canada - Inflation targeting
• Chile - Inflation targeting
• China - Monetary targeting and targets a currency
basket
• Eurozone - Inflation targeting
• Hong Kong - Currency board (fixed to US dollar)
• India - Multiple indicator approach
• New Zealand - Inflation targeting
• Norway - Inflation targeting
• Singapore - Exchange rate targeting
• South Africa - Inflation targeting
• Switzerland - Inflation targeting
• Turkey - Inflation targeting
• United Kingdom - Inflation targeting, alongside
secondary targets on 'output and employment'.
• United States - Mixed policy (and since the 1980s it is
well described by the "Taylor rule," which maintains

17
 that the Fed funds rate responds to shocks in inflation
and output)

MONETARY POLICY TOOLS

Monetary base:
Monetary policy can be implemented by changing the
size of the monetary base. This directly changes the total
amount of money circulating in the economy. A central bank
can use open market operations to change the monetary
base. The central bank would buy/sell bonds in exchange for
hard currency. When the central bank disburses/collects this
hard currency payment, it alters the amount of currency in
the economy, thus altering the monetary base.

Reserve Requirements:
The monetary authority exerts regulatory control over
banks. Monetary policy can be implemented by changing the
proportion of total assets that banks must hold in reserve
with the central bank. Banks only maintain a small portion of
their assets as cash available for immediate withdrawal; the

18
rest is invested in illiquid assets like mortgages and loans.
By changing the proportion of total assets to be held as
liquid cash, the Federal Reserve changes the availability of
loanable funds. This acts as a change in the money supply.
Central banks typically do not change the reserve
requirements often because it creates very volatile changes
in the money supply due to the lending multiplier.

Discount Window Lending:

Many central banks or finance ministries have the
authority to lend funds to financial institutions within their
country. By calling in existing loans or extending new loans,
the monetary authority can directly change the size of the
money supply.

Interest Rates:
The contraction of the monetary supply can be
achieved indirectly by increasing the nominal interest rates.
Monetary authorities in different nations have differing levels
of control of economy-wide interest rates.

In the United States, the Federal Reserve can set the

discount rate, as well as achieve the desired Federal funds
rate by open market operations. This rate has significant
effect on other market interest rates, but there is no perfect
relationship. In the United States open market operations
are a relatively small part of the total volume in the bond
market. One cannot set independent targets for both the
monetary base and the interest rate because they are both
modified by a single tool — open market operations; one
must choose which one to control.

In other nations, the monetary authority may be able to

mandate specific interest rates on loans, savings accounts or
other financial assets. By raising the interest rate(s) under

19
its control, a monetary authority can contract the money
supply, because higher interest rates encourage savings and
discourage borrowing. Both of these effects reduce the size
of the money supply.

Currency Board:
A currency board is a monetary arrangement that pegs the
monetary base of one country to another, the anchor nation.
As such, it essentially operates as a hard fixed exchange
rate, whereby local currency in circulation is backed by
foreign currency from the anchor nation at a fixed rate.
Thus, to grow the local monetary base an equivalent amount
of foreign currency must be held in reserves with the
currency board. This limits the possibility for the local
monetary authority to inflate or pursue other objectives. The
principal rationales behind a currency board are three-fold:

1. To import monetary credibility of the anchor nation;

2. To maintain a fixed exchange rate with the anchor
nation;
3. To establish credibility with the exchange rate (the
currency board arrangement is the hardest form of
fixed exchange rates outside of dollarization).

In theory, it is possible that a country may peg the local

currency to more than one foreign currency; although, in
practice this has never happened (and it would be a more
complicated to run than a simple single-currency currency
board). A gold standard is a special case of a currency board
where the value of the national
currency is linked to the value of gold
instead of a foreign currency.

The currency board in question

will no longer issue fiat money but
instead will only issue a set number of

20
units of local currency for each unit of foreign currency it has
in its vault. The surplus on the balance of payments of that
country is reflected by higher deposits local banks hold at
the central bank as well as (initially) higher deposits of the
(net) exporting firms at their local banks. The growth of the
domestic money supply can now be coupled to the
additional deposits of the banks at the central bank that
equals additional hard foreign exchange reserves in the
hands of the central bank. The virtue of this system is that
questions of currency stability no longer apply. The
drawbacks are that the country no longer has the ability to
set monetary policy according to other domestic
considerations, and that the fixed exchange rate will, to a
large extent, also fix a country's terms of trade, irrespective
of economic differences between it and its trading partners.

Hong Kong operates a currency board, as does

Bulgaria. Estonia established a currency board pegged to the
Deutschmark in 1992 after gaining independence, and this
policy is seen as a mainstay of that country's subsequent
economic success (see Economy of Estonia for a detailed
description of the Estonian currency board). Argentina
abandoned its currency board in January 2002 after a severe
recession.

This emphasized the fact that currency boards are not

irrevocable, and hence may be abandoned in the face of
speculation by foreign exchange traders. Following the
signing of the Dayton Peace Agreement in 1995, Bosnia and
Herzegovina established a currency board pegged to the
Deutschmark (since 2002 replaced by the Euro).

Currency boards have advantages for small, open

economies that would find independent monetary policy
difficult to sustain. They can also form a credible
commitment to low inflation.

21
Unconventional Monetary Policy
At The Zero Bound:
Other forms of monetary policy, particularly used when
interest rates are at or near 0% and there are concerns
about deflation or deflation is occurring, are referred to as
unconventional monetary policy. These include credit
easing, quantitative easing, and signaling.

In credit easing, a central bank purchases private

sector assets, in order to improve liquidity and improve
access to credit. Signaling can be used to lower market
expectations for future interest rates. For example, during
the credit crisis of 2008, the US Federal Reserve indicated
rates would be low for an “extended period”, and the Bank
of Canada made a “conditional commitment” to keep rates
at the lower bound of 25 basis points (0.25%) until the end
of the second quarter of 2010.

Monetary policy can't rein in food

inflation: RBI
BS Reporter | 2010-06-30 01:30:00

Rising food prices have been a concern for the last few
months, but the response to food inflation is beyond the
monetary policy, according to RBI Deputy Governor Subir
Gokarn.

FM hints at rate review in July

"The dynamics of food prices is not the result of one or two
failed monsoons," Gokarn said on the sidelines of the
statistical day seminar organized by RBI.

22
He said the rise in food prices was due to a combination of
shifting consumption patterns, which was pushing up the
demand for primary articles like pulses, even as productivity
of the agriculture sector reached stagnation.

"As affluence spreads, there is diversification in food

consumption patterns. There is a greater emphasis on
protein-rich items, resulting in higher demand for pulses and
milk. The significant part of the rise in food prices was
structural in nature," he added.

India’s food inflation rose to 17.60 per cent in the week

ended June 12 from 16.86 per cent in the previous week.
This rise was mainly due to a hike in the prices of fruits,
vegetables, and spices.

'Rising fuel prices will spur inflation'

Gokarn also pointed out that capacity constraints as well as

deficient rainfall have affected productivity in the farming
sector.

OBJECTIVES OF MONETARY
POLICY
To maintain price stability is the primary objective of
the Euro system and of the single monetary policy for which
it is responsible. This is laid down in the Treaty on the
Functioning of the European Union, Article 127 (1).

"Without prejudice to the objective of price stability",

the Euro system will also "support the general economic
policies in the Community with a view to contributing to the
achievement of the objectives of the Community". These

23
include a "high level of employment" and "sustainable and
non-inflationary growth".

The Treaty establishes a clear hierarchy of objectives

for the Euro system. It assigns overriding importance to
price stability. The Treaty makes clear that ensuring price
stability is the most important contribution that monetary
policy can make to achieve a favorable economic
environment and a high level of employment.

These Treaty provisions reflect the broad consensus that

• The benefits of price stability are substantial (see

benefits of price stability). Maintaining stable prices on
a sustained basis is a crucial pre-condition for
increasing economic welfare and the growth potential
of an economy.
• The natural role of monetary policy in the economy is
to maintain price stability (see scope of monetary
policy). Monetary policy can affect real activity only in
the shorter term (see the transmission mechanism).
But ultimately it can only influence the price level in the
economy.

The Treaty provisions also imply that, in the actual

implementation of monetary policy decisions aimed at
maintaining price stability, the Euro system should also take
into account the broader economic goals of the Community.

In particular, given that monetary policy can affect real

activity in the shorter term, the ECB typically should avoid
generating excessive fluctuations in output and employment
if this is in line with the pursuit of its primary objective.

24
The Federal Reserve sets the nation’s monetary policy to
promote the objectives of maximum employment, stable
prices, and moderate long-term interest rates. The challenge
for policy makers is that tensions among the goals can arise
in the short run and that information about the economy
becomes available only with a lag and may be imperfect.

GOALS OF MONETARY
POLICY
The goals of monetary policy are spelled out in the
Federal Reserve Act, which specifies that the Board of
Governors and the Federal Open Market Committee should
seek “to promote effectively the goals of maximum
employment, stable prices, and moderate long-term interest
rates.” Stable prices in the long run are a precondition for
maximum sustainable output growth and employment as
well as moderate long-term interest rates. When prices are
stable and believed likely to remain so, the prices of goods,

25
services, materials, and labor are undistorted by inflation
and serve as clearer signals and guides to the efficient
allocation of resources and thus contribute to higher
standards of living. Moreover, stable prices foster saving and
capital formation, because when the risk of erosion of asset
values resulting from inflation—and the need to guard
against such losses—are minimized, households are
encouraged to save more and businesses are encouraged to
invest more.

Although price stability can help achieve maximum

sustainable output growth and employment over the longer
run, in the short run some tension can exist between the two
goals. Often, a slowing of employment is accompanied by
lessened pressures on prices, and moving to counter the
weakening of the labor market by easing policy does not
have adverse inflationary effects. Sometimes, however,
upward pressures on prices are developing as output and
employment are softening—especially when an adverse
supply shock, such as a spike in energy prices, has occurred.

Then, an attempt to restrain inflation pressures would

compound the weakness in the economy, or an attempt to
reverse employment losses would aggravate inflation.
In such circumstances, those responsible for monetary policy
face a dilemma and must decide whether to focus on
defusing price pressures or on cushioning the loss of
employment and output. Adding to the difficulty is the
possibility that an expectation of increasing inflation might
get built into decisions about prices and wages, thereby
adding to inflation inertia and making it more difficult to
achieve price stability.

Beyond
influencing the level of
prices and the level of
output in the near term,
the Federal Reserve
can contribute to
financial stability and

26
better economic performance by acting to contain financial
disruptions and preventing their spread outside the financial
sector. Modern financial systems are highly complex and
interdependent and may be vulnerable to wide-scale
systemic disruptions, such as those that can occur during a
plunge in stock prices. The Federal Reserve can enhance the
financial system’s resilience to such shocks through its
regulatory policies toward banking institutions and payment
systems. If a threatening disturbance develops, the Federal
Reserve can also cushion the impact on financial markets
and the economy by aggressively and visibly providing
liquidity through open market operations or discount window
lending.

LIMITATIONS OF MONETARY
POLICY
Monetary policy is not the only force acting on output,
employment, and prices. Many other factors affect
aggregate demand and aggregate supply and, consequently,
the economic position of households and businesses. Some
of these factors can be anticipated and built into spending
and other economic decisions, and some come as a surprise.
On the demand side, the government influences the
economy through changes in taxes and spending programs,
which typically receive a lot of public attention and are

27
therefore anticipated. For example, the effect of a tax cut
may precede its actual implementation as businesses and
households alter their spending in anticipation of the lower
taxes. Also, forward-looking financial markets may build
such fiscal events into the level and structure of interest
rates, so that a simulative measure, such as a tax cut, would
tend to raise the level of interest rates even before the tax
cut becomes effective, which will have a restraining effect
on demand and the economy before the fiscal stimulus is
actually applied.

Other changes in aggregate demand and supply can be

totally unpredictable and influence the economy in
unforeseen ways. Examples of such shocks on the demand
side are shifts in consumer and business confidence, and
changes in the lending posture of commercial banks and
other creditors. Lessened confidence regarding the outlook
for the economy and labor market or more restrictive
lending conditions tend to curb business and household
spending. On the supply side, natural disasters, disruptions
in the oil market that reduce supply, agricultural losses, and
slowdowns in
productivity growth are examples of adverse supply shocks.
Such shocks tend to raise prices and reduce output.
Monetary policy can attempt to counter the loss of output or
the higher prices but cannot fully offset both.
In practice, as previously noted, monetary policy
makers do not have up-to-the-minute information on the
state of the economy and prices. Useful information is
limited not only by lags in the construction and availability of
key data but also by later revisions, which can alter the
picture considerably.

Therefore, although monetary policy makers will

eventually be able to offset the effects that adverse demand
shocks have on the economy, it will be some time before the
shock is fully recognized and—given the lag between a
policy action and the effect of the action on aggregate
demand—an even longer time before it is countered. Add to

28
this the uncertainty about how the economy will respond to
an easing or tightening of policy of a given magnitude, and it
is not hard to see how the economy and prices can depart
from a desired path for a period of time.

The statutory goals of maximum employment and

stable prices are easier to achieve if the public understands
those goals and believes that the Federal Reserve will take
effective measures to achieve them. For example, if the
Federal Reserve responds to a negative demand shock to
the economy with an aggressive and transparent easing of
policy, businesses and consumers may believe that these
actions will restore the economy to full employment;
consequently, they may be less inclined to pull back on
spending because of concern that demand may not be
strong enough to warrant new business investment or that
their job prospects may not warrant the purchase of big-
ticket household goods.

Similarly, a credible anti-inflation policy will lead

businesses and households to expect less wage and price
inflation; workers then will not feel the same need to protect
themselves by demanding large wage increases, and
businesses will be less aggressive in raising their prices, for
fear of losing sales and profits. As a result, inflation will
come down more rapidly, in keeping with the policy-related
slowing in growth of aggregate demand, and will give rise to
less slack in product and resource markets than if workers

29
and businesses continued to act as if inflation were not
going to slow.

Guides To Monetary Policy

Although the goals of monetary policy are clearly
spelled out in law, the means to achieve those goals are not.
Changes in the FOMC’s target federal funds rate take some
time to affect the economy and prices, and it is often far
from obvious whether a selected level of the federal funds
rate will achieve those goals. For this reason, some have
suggested that the Federal Reserve pay close attention to
guides that are intermediate between its operational target
—the federal funds rate—and the economy.

MONETARY AGGREGATES
Monetary aggregates have at times been advocated as
guides to monetary policy on the grounds that they may
have a fairly stable relationship with the economy and can
be controlled to a reasonable extent by the central bank,
either through control over the supply of balances at the
Federal Reserve or the federal funds rate. An increase in the

30
federal funds rate (and other short-term interest rates), for
example, will reduce the attractiveness of holding money
balances relative to now higher-yielding money market
instruments and thereby reduce the amount of money
demanded and slow growth of the money stock. There are a
few measures of the money stock—ranging from the
transactions-dominated M1 to the broader M2 and M3
measures, which include other liquid balances—and these
aggregates have different behaviors.
Ordinarily, the rate of money growth sought over time
would be equal to the rate of nominal GDP growth implied by
the objective for inflation and the objective for growth in real
GDP. For example, if the objective for inflation is 1 percent in
a given year and the rate of growth in real GDP associated
with achieving maximum employment is 3 percent, then the
guideline for growth in the money stock would be 4 percent.
However, the relation between the growth in money and the
growth in nominal GDP, known as “velocity,” can vary, often
unpredictably, and this uncertainty can add to difficulties in
using monetary aggregates as a guide to policy. Indeed, in
the United States and many other countries with advanced
financial systems over recent decades, considerable slip-
page and greater complexity in the relationship between
money and GDP have made it more difficult to use monetary
aggregates as guides to policy. In addition, the narrow and
broader aggregates often give very different signals about
the need to adjust policy. Accordingly, monetary aggregates
have taken on less importance in policy making over time.

The Components Of
The Monetary
Aggregates:
The Federal Reserve publishes
data on three monetary aggregates.
The first, M1, is made up of types of

31
money commonly used for payment, basically currency and
checking deposits.
The second, M2, includes M1 plus balances that generally
are similar to transaction accounts and that, for the most
part, can be converted fairly readily to M1 with little or no
loss of principal. The M2 measure is thought to be held
primarily by households. The third aggregate, M3, includes
M2 plus certain accounts that are held by entities other than
individuals and are issued by banks and thrift institutions to
augment M2-type balances in meeting credit demands; it
also includes balances in money market mutual funds held
by institutional investors.

MONETARY POLICY OF INDIA

Monetary policy in India underwent significant changes
in the 1990s as the Indian Economy became increasing open
and financial sector reforms were put in place. in the
1980s,monetary policy was geared towards controlling the
qunatam,cost and directions
Of credit flow in the economy. the quantity variables
dominated as the transmission Channel of monetary policy.
Reforms during the 1990s enhanced the sensitivity of price
Signals of price signals from the central bank, making

32
interest rates the increasingly Dominant transmission
channel of monetary policy in India.

The openness of the economy, as measured by the

ratio of merchandise
trade(exports Plus imports)
to GDP, rose from about 18%
in 1993-94 to about 26% by
2003-04. Including services
trade plus invisibles, external
transactions as a proportion
of GDP Rose from 25% to
40% during the same period.
Along with the increase in
trade as a Percentage of
GDP, capital inflows have
increased even more sharply ,foreign currency.

Assets of the reserve bank of India(RBI) rose from USD

15.1 billion in the march 1994 To over USD 140 billion by
march 15,2005.these changes have affected liquidity and
Monetary management. Monetary policy has responded
continuously to changes in Domestics and international
macroecomic conditions. In this process, the current
monetary operating framework has relied more on outright
open market operations and Daily repo and reserve repo
operations than on the use of direct instruments. Overnight
Rate are now gradually emerging as the principal operating
target.

The Monetary and Credit Policy is the policy

statement, traditionally announced twice a year, through
which the Reserve Bank of India seeks to ensure price
stability for the economy. These factors include - money
supply, interest rates and the inflation.

33
Objectives:-
The objectives are to maintain price stability and
ensure adequate flow of credit to the Productive sectors of
the economy. Stability for the national currency (after
looking at prevailing economic conditions), growth in
employment and income are also looked into. The monetary
policy affects the real sector through long and variable
periods while the
financial markets are also impacted through short-term
implications.

There are four main 'channels' which the RBI looks at:

Quantum Channel: Money supply and credit (affects

real output and price level through changes in reserves
money, money supply and credit aggregates).

Bank Rate: Bank rate is the minimum rate at which the

central bank provides loans to the commercial banks. It is
also called the discount rate.

Usually, an increase in bank rate results in commercial

banks increasing their lending rates. Changes in bank rate
affect credit creation by banks through altering the cost of
credit.

Cash Reserve Ratio: All commercial banks are required

to keep a certain amount of its deposits in cash with RBI.
This percentage is called the cash reserve ratio. The current
CRR requirement is 8 per cent.

CRR, or cash reserve ratio, refers to a portion of

deposits (as cash) which bank have to keep/maintain with
the RBI. This serves two purposes. It ensures that a portion

34
of bank deposits is totally risk-free and secondly it enables
that RBI controlling equidity in the system, and thereby,
inflation. Besides the CRR, banks are required to invest a
portion of
their deposits in government securities as a part of their
statutory liquidity ratio(SLR) requirements.

The government securities

(also known as gilt-edged
securities or gilts) are bonds
issued by the Central government
to meet its revenue requirements.
Although the bonds are long-term
in nature, they are liquid as they
can be traded in the secondary
market. Since 1991, as the
economy has recovered and sector reforms increased, the
CRR has fallen from 15 per cent in March 1991 to 5.5 per
cent in December 2001. The SLR has fallen from 38.5 per
cent to 25 per cent over the past decade.

Bank rate: 6 %
CRR; 8 %
Repo rate: 7.75%
Reverse Repo rate; 6 %

THE AUSTRALIAN MONETARY

SYSTEM
Australian monetary system requires no minimum reserves
of its banks. This article, based on excerpts from the

35
website of the Reserve Bank of Australia, describes the
essential features.

The Monetary Policy Framework

The centerpiece of the policy framework is an inflation
target, under which the Reserve Bank sets policy to achieve
an inflation rate of 2-3 per cent on average, a rate
sufficiently low that it does not materially affect economic
decisions in the community.

The target provides discipline for monetary policy

decision-making, and serves as an anchor for private sector
inflation expectations. The target is agreed between the
Bank and the Government.

The Implementation Of Monetary

Policy:
Monetary policy is set in terms of an operating target
for the cash rate, which is the interest rate on overnight
loans made between institutions in the money market.
When the Reserve Bank Board decides that a change in
monetary policy should occur, it specifies a new target for
the cash rate. A decision to ease policy will reflect in a new
lower target cash rate, while a decision to tighten policy will
reflect in a new higher target level for the cash rate.

A decision by the Reserve Bank Board to set a new

target for the cash rate is announced in a media release,
which states the new target for the cash rate, together with
the reasons why the Board has taken the decision to change
it. This media release is distributed through electronic news
services on the day on which the change is to take effect,
usually at 9.30 am, the time when the Bank normally
announces its daily dealing intentions.

36
 The Reserve Bank uses its domestic market operations,
sometimes called open market operations, to influence the
cash rate. On the days when monetary policy is being
changed, market operations are aimed at moving the cash
rate to the new target level.

Between changes in policy, the focus of market

operations is on keeping the cash rate close to the target, by
managing the supply of funds available to banks in the
money market - these latter operations are usually referred
to as liquidity management.

Monetary Policy And Debt

Management:
Sound financial policy requires that the Government
fully fund its budget deficit by issues of securities to the
private sector at market interest rates, and not borrow from
the central bank. Many countries have legislation to deliver
this outcome, though in Australia it is effectively achieved by
agreement between the Treasury and the Reserve Bank.
This arrangement means that there is separation between
monetary policy and the Government's debt management,
with the Treasury directly responsible for the latter and the
Reserve Bank responsible for the former.

It is not possible to ensure that the budget deficit is

exactly matched day-by-day by issues of securities to the
market. For one thing, issues generally occur only weekly.
To overcome this mismatch between daily spending and
financing, the Treasury keeps cash balances with the
Reserve Bank which act as a buffer. The Reserve Bank also
provides an overdraft facility for the Government that is
used to cover periods when an unexpectedly large deficit
exhausts cash balances.

37
The Objective Of Monetary Policy:
In Australia, the objectives of monetary policy are
formally established in the Reserve Bank Act. The three
main broad objectives are to maintain:

o inflation at the targeted 2% to 3%

o full employment at the NAIRU (the non-
accelerated inflation rate of unemployment)
between 5% and 7%
o economic growth between 3% and 4% to sustain
the living standards and welfare of the people of
Australia.

To achieve these objectives and determine whether

there is a need to change “monetary stance” (the
loosening or tightening of monetary policy) the Reserve
Bank Board meets once a month to review a check list
of economic indicators. This check list may include:

o levels of consumption expenditure

o indicators of future spending, for example, trends
in housing loans
o surveys of consumer and business confidence
o trends in employment and unemployment
o trends in business investment expenditure
o external sector indicators such as the balance of
payments, CAD and fluctuations in the exchange
rate.

The trends in the check list are then used to guide the
Reserve Bank decisions on monetary stance.

38
 Overview:
Monetary policy refers to the actions taken by the
Reserve Bank of Australia (RBA) to affect monetary and
financial conditions in the money market (also known as the
cash market) to help achieve economic objectives of low
inflation and sustainable growth.

The Reserve Bank is the Government’s monetary

authority and is responsible for formulating and
administrating monetary policy. To achieve non-inflationary
growth the Reserve Bank sets a targeted “cash rate” . For
example, the easing in monetary stance during 2001
stimulated aggregate demand and increased economic
growth.

However, cash rate increases such as the three 0.25%

increases that occurred in May, August and November of
2006, were intended to keep economic growth on target and
reduce inflationary pressures.

When GDP growth in the economy fell, and

unemployment rose because of the international recession
the Reserve Bank reduced interest rates in four separate
occasions. The following graph shows this course of interest
rates.

39
(The pink line shows the interest rate. By 2009 the official interest rate
in Australia had declined to 3%. This low interest rate was designed to
increase growth and investment by lowering he price and cost of
borrowing money.)

MONETARY POLICY OF CHINA

The People's Bank of China was formerly the sole
governor of both monetary policies and "commercial"
banking but has, as a result of the reforms of the post-1978
period, come to serve as the primary monetary policy
making institution in China. It is the Chinese central bank
(the equivalent of the U.S. Federal Reserve Banking System
or the German Bundesbank). Premier Zhu's concerns about
a financial sector crisis were grounded in recognition that
China was quietly moving into the grips of a credit squeeze,
wherein it was becoming increasingly difficult for firms to
find financing for new investment and to pay for
replacement of depreciating plant and equipment (old
investment), and in some cases to finance operations. This
credit squeeze was happening partly as a result of banks
having been granted greater autonomy in making loans.
These banks, components of an elaborate governmental
bureaucracy, had for years acted as state functionaries
implementing a political plan for the economy.

In this regard, bank officials approved politically-

motivated loans to state-owned enterprises (SOE) that were
also components in the bureaucracy and many of these past
loans are in default.

In other words, the bureaucratic machinery had

become clogged when the lending process continued to
function normally, providing a steady stream of money
capital to the SOEs, but the claims (in the form of interest
and principal payments) of the banks on SOE surplus value
were not met: the flow was going in only one direction. Thus,
when given the opportunity, even obligation, to unclog the
machinery, the banks decided to sharply cut back on lending

40
and the roll-over of existing debt, creating the first stages of
a credit squeeze. This seemed, from the bankers standpoint,
to be the most rational response to a situation wherein their
loan portfolios were pock-marked with bad loans. Indeed,
books and articles in China have made a big deal of the fact
that the banks had so many bad loans. It even seemed to be
a civic duty for the bankers to get their house in order by
tightening the standards for granting new loans or rolling
over old ones.

But, of course, the tightening of credit can lead to firms

that are viable becoming unviable. It can lead to a wholesale
deterioration in the health of the "real sector" of enterprises
that produce needed goods. The People's Bank of China
decided to head off this credit crunch by cutting the reserve
requirement from between 16 and 20 percent (depending
upon the size of the bank's asset base and other factors) to
a single rate of 8 percent. The money multiplier (MM =
1/RRR, where MM is the money multiplier and RRR is the
required reserve ratio) tells us that a cut of this magnitude
would double the lending capacity of the banking system.

The hope is that banks will continue to provide loans to

"healthy" firms and avoid a financial sector crisis. We will
discuss whether or
not this is likely to
succeed, but a key
point that you
should consider in
this regard is not
only whether or not banks will actually continue lending to
the best available borrowers, but whether "healthy" firms
would actually want to borrow under current conditions.

If export growth is slowing, foreign direct investment is

falling, and firms are starting to show strains in generating
enough revenues to pay interest (and maturing principal) on
loans, then we can conclude that the demand side of the
Chinese economy is weakening.

41
 If the economy is weakening then firms are not as
likely to be out aggressively hiring recent graduates or more
workers. Some of the former graduate students I worked
with in China have confirmed that the employment situation
in China is not quite as good as it was in 1996 and 1997.
There is some concern that the employment situation could
get worse if the government doesn't counteract the
aforementioned negative effects on aggregate demand for
products and services.

The Zhu administration is not willing to rely solely on

monetary policy to keep the economy growing. He has also
moved to stimulate spending directly. The Zhu
administration has proposed a record budget with about 122
billion dollars in spending for the coming fiscal year. This
spending is designed to dramatically boost aggregate
demand for goods and services (via the responding
multiplier effect) and provide firms with the needed market
for their output. If firms can sell their output and generate
revenues, then they will be in a better position to pay the
interest (and maturing principal) on their loans. The financial
sector crisis, hopefully, can be averted and unemployment
also reduced.

These policies are designed to avoid the potential social

unrest from an economic crisis. Premier Zhu and the rest of
the Chinese leadership do not want to see anything like
Indonesia's social problems within China's boundaries (or,
even, the sort of unrest that is growing in Malaysia).

In order to finance the government fiscal stimulus

package, the Zhu administration has decided to take the
Keynesian approach of increased deficit spending. Zhu
Rongji's administration wants to partly finance the
government budget by a record 44 billion dollars in
government debt (double the debt issue of only three years
ago). This debt would constitute about 36 percent of the
total 122 billion dollars of expenditures in this year's budget
with the remainder covered by government revenues from
taxes and fees. Final approval of administration budgets

42
comes from the national People's Congress, which has
shown no inclination for going against the top leadership's
proposals.

In a further effort to avoid financial problems, the Zhu

administration has also decided to finance a special fund to
recapitalize commercial banks (buy bad loans from the
commercial banks and, therefore, add more to the capital
base of the banks) by issuing almost 33 billion dollars in
special 30-year bonds. This is in addition to the
aforementioned 44 billion dollars in debt, bringing the total
debt issuance to 77 billion dollars. The fact that the
government is willing to borrow such a large amount is
indicative of the concerns about an economic slow-down.
The Chinese leadership has traditionally been much more
conservative about their borrowing.

The bond-balance-to-GDP ratio in China has grown from

2.45 percent in 1991 to 4.2 percent last year. It is expected
that this ratio will rise to 5.95 percent this year. This ratio is
still a relatively modest bond-balance-to-GDP ratio and
nothing like what one would find in Thailand or Indonesia or
South Korea. However, the trend is somewhat troubling. At
the moment, the rate of growth of the Chinese economy
continues to exceed this bond-balance-to-GDP ratio,
indicating that the Chinese
economy can generate
enough revenues to
continue paying for the
debt.

In addition, the ratio of

bond-balance-to-household-
savings is expected to be
about 9 percent this year, not a particularly large number
either (especially given the relatively few options for Chinese
household savers). This means the Chinese government
should be able to find a ready market for these bonds. And
China's overall debt load is miniscule compared to that of a
country like Italy, which has a debt-to-GDP ratio of about

43
120%. These factors indicate that the Chinese government
still has some flexibility in using debt to finance public
expenditures and infrastructure investments. However, this
also indicates that the current leadership is willing to
"mortgage" future revenues to pay for current spending. In
other words, the current leadership is so concerned about
the impact of an economic slowdown that they are willing to
borrow much more heavily than has been traditional among
the post-1949 governments and let someone else figure out
how to pay the interest and principal. Does this sound
familiar?

China has avoided the worse of the Asia-wide economic

crisis. Growth has slowed but is still both positive and
greater in magnitude than the growth rates of most
countries.
If the pragmatic modernists are correct in their assumption
that continued "modernization" is a prerequisite for social
progress (for reinforcing socialism and clearing the path for
communism), then we can view their current policies as not
only an attempt to avoid social unrest and keep the leftists
at bay, but also as consistent with their overall philosophy of
building "socialism with Chinese characteristics."

44
 MONETARY POLICY OF
SINGAPORE
The key objective of Singapore's monetary policy is to
maintain price stability for sustained economic growth. Since
1981, monetary policy in Singapore has been centered on
the exchange rate. This reflects the fact that in the small
and open Singapore economy where imports and exports
amount to more than twice GDP, the exchange rate is the
most effective tool in controlling inflation.

The MAS manages the Singapore dollar (S$) exchange

rate against a trade-weighted basket of currencies of
Singapore's major trading
partners and competitors.
The composition of this
basket is reviewed and
revised periodically to take
into account changes in
Singapore's trade patterns.
This trade-weighted
exchange rate is
maintained broadly within
an undisclosed target band, and is allowed to appreciate or
depreciate depending on factors such as the level of world
inflation and domestic price pressures. MAS may also
intervene in the foreign exchange market to prevent
excessive fluctuations in the S$ exchange rate.

45
 Monetary policy is reviewed on a semi-annual basis to
ensure that it is consistent with economic fundamentals and
market conditions, thereby ensuring low inflation for
sustained economic growth over the medium term. The MAS
publishes a semi-annual Monetary Policy Statement (MPS) in
April and October which explains its assessment of
Singapore's economic and inflationary conditions and
outlook, and sets out its monetary policy stance for the
following six months.

Singapore's exchange rate-based monetary policy

system and its experience since its adoption are reviewed in
MAS' monograph on Singapore's Exchange Rate Policy .

In the context of Singapore's open capital account, the

choice of the exchange rate as the focus of monetary policy
would necessarily imply that domestic interest rates and
money supply are endogenous. As such, MAS' money market
operations are conducted mainly to ensure that sufficient
liquidity is present in the banking system to meet banks'
demand for reserve and settlement balances.

The key aspects of MAS'

monetary policy operations,
viz. foreign exchange and
money market operations,
and the various factors and
considerations underlying
them, are discussed in MAS'
monograph on Monetary
Policy Operations in Singapore .

46
MONETARY POLICY OF JAPAN
Monetary policy pertains to the regulation, availability,
and cost of credit, while fiscal policy deals with government
expenditures, taxes, and debt. Through management of
these areas, the Ministry of Finance regulated the allocation
of resources in the economy, affected the distribution of
income and wealth among the citizenry, stabilized the level
of economic activities, and promoted economic growth and
welfare.

The Ministry of Finance played an important role in

Japan's postwar economic growth. It advocated a "growth
first" approach, with a high proportion of government
spending going to capital accumulation, and minimum
government spending overall, which kept both taxes and
deficit spending down, making more money available for
private investment. Most Japanese put money into savings
accounts, mostly postal savings.

National Budget:
In the postwar period, the government's fiscal policy
centers on the formulation of the national budget, which is
the responsibility of the Ministry of Finance. The ministry's
Budget Bureau prepares expenditure budgets for each fiscal
year based on the requests from government ministries and
affiliated agencies. The ministry's Tax Bureau is responsible

47
for adjusting the tax schedules and estimating revenues.
The ministry also issues government bonds, controls
government borrowing, and administers the Fiscal
Investment and Loan Program (FILP), which is sometimes
referred to as the "second budget."

Three types of budgets are prepared for review by the

National Diet each year. The general account budget
includes most of the basic expenditures for
current government operations. Special account
budgets, of which there are about forty, are
designed for special government programs or
institutions where close accounting of revenues
and expenditures is essential: for public
enterprises, state pension funds, and public works projects
financed from special taxes. Finally, there are the budgets
for the major affiliated agencies, including public service
corporations, loan and finance institutions, and the special
public banks. Government fixed investments in
infrastructure and loans to public and private enterprises are
about 15 % of GNP. Loans from the Fiscal Investment and
Loan Program, which are outside the general budget and
funded primarily from postal savings, represent more than
20 % of the general account budget, but their total effect on
economic investment is not completely accounted for in the
national income statistics. Government spending,
representing about 15 % of GNP in 1991, was low compared
with that in other developed economies. Taxes provided
84.7 % of revenues in 1993. Income taxes are graduated
and progressive.

The principal structural feature of the tax system is the

tremendous elasticity of the individual income tax. Because
inheritance and property taxes are low, there is a slowly
increasing concentration of wealth in the upper tax brackets.
In 1989 the government introduced a major tax reform,
including a 3 % consumer tax. This tax has been raised to
5 % by now.

48
 After the breakdown of the economic bubble in the
early 1990s the country's monetary policy has become a
major reform issue. US economists have called for a
reduction in Japan's public spending, especially on
infrastructure projects, to reduce the budget deficit. To force
a reduction of the loan program, partially financed through
postal savings, then-Prime Minister Junichiro Koizumi aimed
to push forward postal privatization. The postal deposits, by
far the largest deposits of any bank in the world, would help
strengthening the private banking sector instead.

Budget process:
The Budget Bureau of the Ministry of Finance is at the
heart of the political process because it draws up the
national budget each year. This responsibility makes it the
ultimate focus of interest groups and of other ministries that
compete for limited funds. The budgetary process generally
begins soon after the start of a new fiscal year on April 1.
Ministries and government agencies prepare budget
requests in consultation with the Policy Research Council. In
the fall of each year, Budget Bureau examiners reviews
these requests in great detail,
while top Ministry of Finance
officials work out the general
contours of the new budget and
the distribution of tax revenues.
During the winter, after the
release of the ministry's draft
budget, campaigning by
individual Diet members for
their constituents and different
ministries for revisions and supplementary allocations
becomes intense. The coalition leaders and Ministry of
Finance officials consult on a final draft budget, which is
generally passed by the Diet in late winter..

49
 THE UNITED STATES
MONETARY SYSTEM
During the colonial period, coins from different
European countries were used and circulated throughout the
colonies. Spanish coins were the dominate currency and
because of the scarcity of coins, much of the trade and
commerce was accomplished by bartering and trade, and
commodities such as rice, tobacco, animal skins, and rum,
were actually used as money.

Paper notes and other currencies were issued by some

of the colonies with varying rates of discount which made
them little more than worthless and not acceptable for most
purchases or for payment of any kind.

During the American Revolution, the Continental

Congress issued the first unified currency which was
declared redeemable in gold and silver but after the war and
independence, redemption became almost nil because of
excessive printing of the notes over metal reserves and the
notes lost almost
all of their value.

50
 Because of a sharp rise in population and a big increase
in trade and commerce, the newly formed United States
government started looking at ways to institute a strong,
stable, central monetary policy.

It wasn't until 1792 that Congress was given the power

to create and establish a national monetary system. At that
time, Congress passed the Coinage Act and made the dollar
the nation’s primary monetary unit.

The Coinage Act of 1792 was based on the use of gold

and silver reserves but because of the scarcity of the
precious metals at the time, adjustments in value occurred
frequently.

Throughout U.S. history, especially after gold was

discovered in California, revision of the coinage laws and the
mint ratio of gold and silver coins increased or decreased as
the economics of the times dictated.

In 1913, the Federal Reserve Act was passed

authorizing the establishment of regional Federal Reserve
Banks (Federal Reserve System) that issue money to
member banks by drawing on their own deposits or by
borrowing commercial paper if their deposit balances with
the Federal Reserve are insufficient..

The United States monetary system is designed to have

the flexibility to meet the needs of the general population
and to stimulate the economy when stimulation is deemed
necessary.

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 CONCLUSION
To sum up, despite sound fundamentals and no
direct exposure to the sub-prime assets, India was
affected by global financial crisis reflecting increasing
globalization of the Indian economy. The policy response
has been swift. While fiscal stimulus cushioned the
deficiency in demand, monetary policy augmented both
domestic and foreign exchange liquidity. The
expansionary policy stance of the Reserve Bank was
manifested in significant reduction in CRR as well as the
policy rates.

The contraction of the Reserve Bank’s balance

sheet resulting from the decline in its foreign assets
necessitated active liquidity management aimed at
expanding domestic assets, which was ensured through
OMO including regular operations under the LAF,
unwinding of MSS securities, introduction of new and
scaling up of existing refinance facilities. In addition,
sharp reductions in CRR besides making available primary
liquidity raised the money multiplier and ensured steady
increase in money supply.

The liquidity injection efforts of the Reserve Bank

could be achieved without compromising either on the
eligible counterparties or on the asset quality in the
Reserve Bank’s balance sheet. Moreover, the Reserve
Bank’s balance sheet did not show any unusual increase,
unlike that of several other central banks.

At present, the focus around the world and also in

India has shifted from managing the crisis to managing
the recovery. The key challenge relates to the exit
strategy that needs to be designed, considering that the
recovery is as yet fragile but there is an up tick in
inflation, though largely from the supply side, which could
engender inflationary expectations. Thus, the Reserve
Bank has initiated the first phase of exit in its October

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2009 Review of monetary policy in a calibrated manner
mainly by withdrawal of unconventional measures taken
during the crisis.

BIBLOGRAPHY

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