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Monetary policy2
1.
2. Medium of exchange
Unit of account
Measure of value
Standard of deferred payments
The classic definition of money is thus
“money is what money does”
4. M 1 = currency in circulation + demand deposits +
other deposits
M2 = m1 + cds + term deposits less than 1 yr
M3 = m2 + term deposits exceeding one year +
call borrowings from the ndfcs by the banking
system
M0 = currency + bankers deposits + other
deposits
5.
Issue of currency notes
Custodian of foreign exchange reserves
Banker to the Government
Banker to other banks
a) custodian of cash reserves
b) lender of last resort
c) clearing agent
Credit control
Promotional role
6. Objectives:
a) stabilisation of price level
b) stabilisation of money market
c) promoting economic growth
Instruments:
a) qualitative- controlling the direction of credit
b) quantitative – controlling the volume of credit
7. Bank rate: rate at which central banks lend to the
commercial banks
Variable Reserve Ratios
1. cash reserve ratio (crr)
2. statutory liquidity ratios (slr)
3. repo and reverse repo rates
Open Market operations- buying and selling
Government bonds.
10. Step 1: open market operations (sell securities)
leads to reduction in bank reserves
Step 2: reduction in money supply
Step 3:this causes interest rates to rise
(tight money situation)
Step4:investment falls ( agg. Demand falls)
Step 5: reduction in income, output, employment
and prices.
11. liabilities
assets
1. Share capital
1. Cash in hand, cash with central
bank, cash with other banks
2.Money at call
2. Reserve funds
3. Deposits – time, demand savings
4.borrowings
3.Bills discounted including treasury
bills
4.Investments
5.Other items
5.Advances
6.others
12. An open market purchase of securities by RBI will
result in an increase in reserves spread out
among all the banks.
If the RBI purchases Rs 1000 worth G- secs from
a dealer , and pays in cheques.
The dealer will deposit that in the commercial
bank A whose deposits increase by 1000
13. If the reserve requirements are 20%, the Bank A
can lend out Rs 800.
Every loan creates a deposit . Hence in the
balance sheet the loans and deposits will
increase by 800.
The borrower of 800 will deposit it in his own bank
B whose deposits will increase by 800.
Bank B will keep 20%as reserves and lend out
640, thereby creating a new deposit.
The borrower of Rs 640 will deposit in his Bank C.
14.
Total deposit creation will be :
1000+800+640+512…………..
=1000(1+.8+.82+……..)
= 1000(1/1-.8) =5000
Deposit multiplier = 5 = 1/r
r= reserve deposit ratio
15.
1.
2.
3.
Limitations to deposit creation:
Public varies its currency holdings
Banks choose to hold excess reserves
Commercial banks have time as well as demand
deposits
17.
If there is a currency withdrawal from Rs 1000.
( CURRENCY DEPOSIT RATIO IS 0.1)
Then the customer will withdraw Rs 91 in cash and keep
Rs 909in deposits.
The banks have to keep 20% as crr. So it will lend Rs
727 .
C(n+I )+D(n+1) = .8D(n).
C(n+1)=.1D(n+1)
1.1D(n+1) = .8D(n)
D(n+1)= .727D(n)
Total deposits = 909+661+481+…
909[1+.727+(.727)2 +(.727)3 +….] =3330
Total Currency = 0.1(3330) =333
18. Liabilities:
Monetary liabilities are:
Notes in circulation
Deposits of financial institutions
Deposits of foreign central banks
Accounts of international agencies - IMF
Deposits of banks (Reserves)
19. Non monetary liabilities are:
Capital account (net worth)
• Paid up capital + contingency reserves
Government deposits
IMF Account no. 1
Misc. – CD, PPF , BILLS
HIGH POWERED MONEY = MONETARY
LIABILITIES OF RBI + GOVT MONEY
20. FINANCIAL ASSETS:
A. RBI credit to commercial sector
Shares/ bonds of financial institutions
Debentures of co-operative sector/banks
Loans to financial institutions
Internal bills purchased and discounted
B. RBI Credit to Government
C. RBI’s gross claims on banks
Refinance of RBI to banks
Fixed investment in bank shares / bonds
21. D. Net foreign assets
Gold coins and bullion
Foreign securities
Balances held abroad
OTHER ASSETS :
Physical assets
Others
Monetary liabilities + nonmonetary liabilities
= financial assets + other assets
22. H = Currency + Reserves
◦ Currency is held by public and by banks
◦ Reserves = vault cash + banks deposits
with RBI
= Statutory reserves +excess reserves
(FA)+(OA) = ML+NML
FA +OA –NML =ML
Let NET NML =NML –OA
Thus FA- NNML=ML
23. Changes in RBI credit to Government
Changes in RBI credit to commercial bank
Changes in RBI credit to commercial sector
Changes in foreign exchange reserves
25. c=currency deposit ratio
r =reserve deposit ratio
M = (1+c)/(c+r)H
Thus money supply is a multiple of high
powered money.
c depends on the cost and convenience of
holding cash
r depends on regulations as well as interest
rate. Reserves include excess cash (vault
cash)
26. RBI’s ability to control the stock of money
depends on the control over H and the stability
and predictability of the money multiplier.
Since c cannot be changed easily, any change
in the money multiplier is through r
27. Volumes of financial flows can be used to define
various ratios of financial development
Finance ratios= total financial claims/national
income. Shows the relation between financial
development and economic development.
Financial interrelations ratio = financial claims/ net
physical capital formation.
it shows the relation between financial assets and
physical assets.
28.
New issue ratio: primary issues/ net physical
capital formation. It shows the degree of financial
dis-intermediation.
(primary issues are issued by deficit spenders
directly to the surplus spenders)
Intermediation ratio: secondary issues/ primary
issues.. It is a measure of financial intermediation.
