MONETARY POLICY

Monetary Policy

Monetary policy is the management of money supply

and interest rates by central banks to influence prices
and employment.
Monetary policy works through expansion or
contraction of investment and consumption of
expenditure.
At times of recession monetary policy involves the
adoption of some monetary tools which tends to
increase the money supply and lower interest rate.
At the time of inflation monetary policy seeks to 2
contract aggregate spending by tightening the money
supply or raising the rate of return.
 The uses of Monetary Policy
There is no long-term tradeoff between growth
and inflation. (High inflation can only hurt
growth).
What monetary policy – at its best – can deliver is
low and stable inflation, and thereby reduce the
volatility of the business cycle.
When inflationary pressures build up: raise the
short-term interest rate (the policy rate) which
raises real rates across the economy which
squeezes consumption and investment.
It is not concentrated at a few points, as is the case
with government interventions in commodity
markets. 3
 Three Important Objectives
• To ensure the economic stability at full
employment or potential level of output.

• To achieve price stability by controlling

inflation and deflation.

• To promote and encourage economic growth

in the economy. 4
 Tools Of Monetary Policy
• Bank rate policy
• Open market operations
• Changing Cash Reserve Ratio
• Statutory Liquidity Ratio
• Changes in repo rate and reverse repo rate
• Net purchase of foreign currency assets

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 Bank Rate policy
• Bank rate is the minimum rate at which the
central bank of a country provides loan to the
commercial bank of the country.

• Bank rate is also called discount rate because

bank provide finance to the commercial bank
by rediscounting the bills of exchange.

• When central bank raises the bank rate, the

commercial bank raises their lending rates, it
results in less borrowings and
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reduces money
supply in the economy.
 Open Market Operations

• It means the purchase and sale of

securities by central bank of the country.

• It is useful for the developed countries.

• The sale of security by the central bank

leads to contraction of credit and purchase
there of to credit expansion.
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 Cash reserve Ratio
• The bank have to keep certain amount of
bank money with themselves as reserves
against deposits.
• The increase in the cash rate leads to the
contraction of credit only when the banks
excess reserves.
• The decrease in the cash rate leads to the
expansion of credit and banks tends to
make more available borrowers.
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STATUTORY LIQUIDITY RATIO
•Statutory Liquidity Ratio (SLR) is a term used
in the regulation of banking in India.
•It is the amount which a bank has to maintain
in the form of cash, gold or approved
securities.
•The objectives of SLR are :-
1)To restrict the expansion of bank credit.
2)To augment the investment of the banks
in Government securities.
3)To ensure solvency of banks.
 Repo rate System
• It is introduced through which RBI can add to
liquidity in the banking system. Through repo
system RBI buys securities from the bank and
there by provide funds to them.

• Repo refers to agreement for a transaction

between RBI and banks through which RBI
supplies funds immediately against government
securities and simultaneously agree to repurchase
the same or similar securities after a specified
time which may be one day 10
to 14 days.
 Thank You
“We need faster growth because, at our level of incomes, there can be
no doubt that we must expand the production base of the economy if
we want to provide broad-based improvement in the material conditions
of living of our population, ..........
But growth alone is not enough if it does not produce a flow of benefits
that is sufficiently wide-spread. We, therefore, need a growth process
that is much more inclusive, .......... and which also ensures access to
essential services such as health and education for all sections of the
community”.

-Dr. Manmohan Singh,

Prime Minister
MONETARY POLICY
 Introduction
Fiscal policy refers to the government policies
regarding taxation, public borrowing and public
expenditure with specific objectives in view.
• Its main objective is to achieve “economic
development”.
• The use of fiscal policy as an economic tool was
proposed by Keynes and gained popularity during
the time of ‘Great Depression’.
 Economic Stabilization
Fiscal policy responses to economic instability in
to ways:
Automatic Stabilizers: built-in stabilizers
• Incremental Tax Rates – Tax rate applicable
increases as the income increases.
• Unemployment compensation and Welfare
payments.

Discretionary Fiscal Policy: deliberate changes

undertaken by the government in the tax rates and
planned outlays.
 Fiscal Policy And
Macroeconomic Goals
• Economic Growth: By creating conditions for
increase in savings & investment.
• Revenue mobilization: mobilization of resources
through taxation.
• Allocational efficiency: efficient and rational
allocation of resources.
• Stabilization: fight with depressionary trends and
booming (overheating) indications in the economy
• Economic Equality: By reducing the income and
wealth gaps between the rich and poor.
 Instruments of Fiscal Policy
• Taxation- direct and indirect
• Public borrowing
• Deficit financing
• Public expenditure
 Taxation
• It is the most important source of public revenue.
• It determines the level of disposable income with
the individuals
• Classified into
1. Direct taxes- Corporate tax, Div. Distribution Tax,
Personal Income Tax, Fringe Benefit taxes, Banking Cash
Transaction Tax
2. Indirect taxes- Central Sales Tax, Customs, Service
Tax, excise duty.
 Public Borrowing
• Internal borrowings
1. Borrowings from the public by means of treasury bills
and govt. bonds
2. Borrowings from the central bank (monetized deficit
financing)
• External borrowings
1. foreign investments
2. international organizations like World Bank &
IMF
3. market borrowings
 Deficit Financing
• When government spendings are more than
revenue.
• Keeping budget balanced (R=E) or deficit
(R<E) or surplus (R>E) as a matter of
policy is itself a fiscal instrument.
• It is used as a tool to boost employment.
• The gap between expenditure and revenue
is filled by “deficit financing”
 Government Expenditure
 It includes :
• Government spending on the purchase of goods &
services.
• Expenditure on providing basic facilities to the
public
• Undertaking infrastructural projects
• Payment of wages and salaries of government
servants
• Public investment
• Transfer payments
 Some problems
• Lags in fiscal policy
• Problems in tax policy
• Burden of public debt
• The dangers of deficit financing