MANAGERIAL ECONOMICS

GROUP 4

TOPIC

EFFECTS OF MONETARY POLICY

ON ECONOMY

PRESENTED BY –
PRESENTED TO – AKSHAT JAIN
DR. NAVITA NATHANI PRACHI MANGAL
SANKALP SHUKLA
 INTRODUCTION
• Monetary policy is an economic policy that manages the size
and growth rate of the money supply in an economy. It is a
powerful tool to regulate macroeconomic variables.

These policies are implemented through different tools,

including the -
• adjustment of the interest rates,
• purchase or sale of government securities,
• and changing the amount of cash circulating in the
economy
• This role is played by a central bank of the nation,
• which in India’s case is Reserve Bank of India (RBI) and in the
USA’s case, its Federal Reserve.
• Several actions in monetary policy include
• changing of interest rates (repo),
• purchasing or selling government bonds via direct action in the
market,
• and changing the amount of money, banks are required to
maintain as reserves with RBI using tools like cash reserve
ratio (CRR) and statutory liquidity ratio (SLR).
 Objective

• Monetary policy is one of the tools of controlling money supply in

an economy of a nation by the monetary authorities in order to
achieve a desirable economic growth.
• Governments try to control the money supply because most
governments believe that its rate of growth has an effect on the
rate of inflation.
• Hence, monetary policy comprises those government actions
designed to influence the behaviour of the monetary sector.
• Monetary policy may be inflationary or deflationary depending
upon the economic condition of the country.
• Three basic kinds of monetary policy decisions can be made
about
(1) The amount of money in circulation;
(2) The level of interest rate; and
(3) The functions of credit markets and the banking system

• The combination of these measures is designed to regulate the

value, supply and cost of money in an economy, in line with the
level of economic activity.
• For example,
when the central bank raises repo rates, banks are said to
follow with raising lending rates, which leads to less borrowing
by retail and industrial customers, less money supply in the
economy and thereby leading to lower demand and easing of
inflation.
 Effects of monetary policies

• Monetary policy consists of a Government’s formal efforts to

manage the money in its economy in order to realize specific
economic goals.

• Generally, when RBI tries to revive economic growth, it

adopts expansionary monetary policy wherein it increases the
availability of liquidity in the financial system in order, to boost
demand
• . The expansionary monetary policy generally has its effects,
as shown in Figure 1.
• On the other hand, when RBI sets out to control high levels of
inflation in the economy,
• it adopts contractionary monetary policy wherein it decreases
the liquidity in the financial system, as a result of which
demand is subdued to a certain extent, and the inflation
reduces.
• Contractionary monetary policy leads to a reduction in the
supply of credit and which leads to a decline in investments
and supply of money, which ultimately controls inflation.
• central bank always needs to be careful while using monetary
policy as a tool to deal in difficult economic situations.
 LET US UNDERSTAND WITH A CASE STUDY
• Case : subprime crisis of 2008

• The 2008 Global Financial Crisis, also known as the ‘2008 Recession’, or ‘The
Subprime Crisis’ has been described by International Monetary Fund (IMF) as a most
terrible crisis since the Great Depression of the 1930s (Bernanke, 1983). As stated by
Warren Buffett, “The system had stopped”.
• Lehman Brothers, most prominent and largest investment bank in the world and
supposedly in the list of ‘Too big to fail’ had collapsed due to massive losses and high
exposure to risk assets.
• In spite of the wide-ranging efforts of the US Government to revive economic activity
during the period of the recession, millions of people lost jobs, and the unemployment
rate peaked at 10%. Due to an interconnected and globalised world and the USA
being a major trade partner for many countries, the ripple effects of the crisis in the
USA spread to developed nations as well as the developing nations in the world.
• Why India was less affected

• The lending norms and practices setup by RBI for the Indian banks were strict.
• A significant role played in the Indian lending market was performed by the
nationalised banks, which adhered to regulations of the central bank. Apart from
CRR regulations, banks had to maintain SLR to the extent of 25%.
• Reddy (2000), RBI Governor, had started raising interest rates and building up
reserves. Subbarao, RBI Governor, who assumed charge after Reddy
formulated several monetary policies to help India steer clear of recessionary
phase.
• He worked closely with the government and made good use of the excess
liquidity RBI had acquired, during the boom years. In fact, during the period of
global instability, India managed to lower interest rates. It is, however, true that
the stock market, money market and foreign exchange market were affected.
Because of the crisis, the overseas financing of these markets dried up.
• Post subprime crisis India’s GDP progress rate slowed down to
6.8%, which was around 9% recorded during the previous three
financial years. Demand for goods and services in the Indian
economy remained more or less consistent during the global
economic crisis.
• To counter the spill-over effects of the crisis on the domestic
economy, the RBI adopted multiple monetary policies. Quantitative
tools such as SLR, CRR, market stabilisation scheme, repo and
reverse repo and operations in the open market. Apart from it,
qualitative monetary policy tools were effectively used, such as
special market operations
.
• RBI’s monetary measures helped provide the market with the liquidity of over INR4,220
billion during the crisis period. Several measures taken by RBI during the crisis period, on
the monetary front, are discussed as follows.
• On 29 September 2008, RBI reduced its repo rate by 0.50%. The lowering of this policy
rate continued further. Repo rate was further reduced by 4.25%, which was 9% in October
2008 to 4.75% in April 2009. As a result, various Indian banks reduced their prime lending
rate (PLR) to around 12%.
• The lower lending rates led to lower cost of borrowing from the banks. As a result, more
credit was availed for investment by the companies, and there was more demand for
durable consumer goods. In tandem, the reverse repo was further altered to 3.25%. To
ensure sufficient flow of money and flow of credit to industries, CRR was brought down
from 9% to 5% (4% decrease) of net demand and time liabilities.
• The step resulted in an infusion of INR1.6 trillion of primary liquidity in the market. Liquidity
was expanded into the system through market stabilisation scheme.
• Reserve bank increased export loan refinance cap for banks from 15% to 50%. Reserve
bank brought down SLR to 24% of NDTL, which was 25% before. It freed up INR200
billion to banks for their lending operations.
 Conclusions
• It can be seen from the case studies above; monetary policy plays a significant role in
providing an ideal economic environment for a country, especially in the case of
economic turbulence.
• Crisis of 2008 gave the lessons that it is best to be prepared for the worst. Reddy, had
prepared India to deal with a global recession-like situation, much before its occurrence
by building up foreign exchange reserves, pushing Indian bank for conservative lending
through strict lending norms and restricting Indian banks from any exposure to complex
financial products.
• During the times of recession, it makes sense to release liquidity in the market through
lowering interest rates and relaxing reserve requirements of banks. It also calls that the
interest rates have to be moderate, or even, on a higher side during boom and prosperity
phases. As we can see that, the US Fed cannot lower interest further, because they are
already touching zero. After recovering from the recession, liquidity can slowly be
squeezed.
• Another important lesson to learn from the 2008 Recession is that RBI and the
government must work in tandem, in such difficult situations.
THANK YOU