Description
monetary policy in detail and it contains topics like functions of money, functions of central bank, credit control, monetary transmission mechanism, credit creation, balancesheets of banks and RBI, finance ratios
MONETARY POLICY
FUNCTIONS OF MONEY
? 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”
Monetary Aggregates:
? M1=
currency + demand deposits + other deposits ? M2 = M1 + post office savings deposits ? M3 = M1 + term deposits ? M4 = M3+Post office savings deposits
Functions of Central Bank
? ? ? ?
? ?
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
Credit Control
? 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
Quantitative Credit Controls
? 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.
Current Rates:
CRR SLR BANK RATE REPO RATE REVERSE REPO RATE 5% 25% 6% 4.75% 3.25%
Qualitative Credit Control
? Margin
requirements ? Regulation of consumer credit ? Credit rationing ? Moral Suasion ? Direct action
Monetary Transmission Mechanism
? 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.
Balance sheet of banks
liabilities 1. Share capital assets 1. Cash in hand, cash with central bank, cash with other banks 2.Money at call 3.Bills discounted including treasury bills 4.Investments 5.Advances 6.others
2. Reserve funds 3. Deposits – time, demand savings 4.borrowings 5.Other items
Credit Creation by Commercial Banks
? 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
? 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.
? 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
?
Limitations to deposit creation:
Public varies its currency holdings Banks choose to hold excess reserves Commercial banks have time as well as demand deposits
1. 2. 3.
Multiple expansion of demand Deposits
RESERVES Bank A Bank B Bank C Bank D 200 160 128 102 LOANS 800 640 512 410 DEPOSITS 1000 800 640 512
Bank E
82
328
410
? 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
. ? C(n+1)=.1D(n+1) ? 1.1D(n+1) = .8D ? D(n+1)= .727D ? Total deposits = 909+661+481+… ? 909[.727+(.727)2 +(.727)3 +….] =3330 ? Total Currency = 0.1(3330) =333
Balance Sheet of RBI:
? 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)
? 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
ASSETS OF RBI:
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
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
H = Currency + Reserves
? Currency
High Powered Money is held by public and by banks
= vault cash + banks deposits
? Reserves
with RBI = Statutory reserves +excess reserves (FA)+(OA) = ML+NML FA +OA –NML =ML Let NET NML =NML –OA Thus FA- NNML=ML
SOURCES OF CHANGES IN H
? 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
Money multiplier:
? Money
Supply= currency+deposits ? High powered money(H)= Currency + reserves. ? M = C+D M/D = C/D+1 =c+1 H/D = C/D +R/D = c+r
? 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)
? 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
Finance ratios
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.
?
? New
issue ratio: primary issues/ net physical capital formation. It shows the degree of financial disintermediation. (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.
doc_508098134.ppt
monetary policy in detail and it contains topics like functions of money, functions of central bank, credit control, monetary transmission mechanism, credit creation, balancesheets of banks and RBI, finance ratios
MONETARY POLICY
FUNCTIONS OF MONEY
? 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”
Monetary Aggregates:
? M1=
currency + demand deposits + other deposits ? M2 = M1 + post office savings deposits ? M3 = M1 + term deposits ? M4 = M3+Post office savings deposits
Functions of Central Bank
? ? ? ?
? ?
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
Credit Control
? 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
Quantitative Credit Controls
? 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.
Current Rates:
CRR SLR BANK RATE REPO RATE REVERSE REPO RATE 5% 25% 6% 4.75% 3.25%
Qualitative Credit Control
? Margin
requirements ? Regulation of consumer credit ? Credit rationing ? Moral Suasion ? Direct action
Monetary Transmission Mechanism
? 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.
Balance sheet of banks
liabilities 1. Share capital assets 1. Cash in hand, cash with central bank, cash with other banks 2.Money at call 3.Bills discounted including treasury bills 4.Investments 5.Advances 6.others
2. Reserve funds 3. Deposits – time, demand savings 4.borrowings 5.Other items
Credit Creation by Commercial Banks
? 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
? 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.
? 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
?
Limitations to deposit creation:
Public varies its currency holdings Banks choose to hold excess reserves Commercial banks have time as well as demand deposits
1. 2. 3.
Multiple expansion of demand Deposits
RESERVES Bank A Bank B Bank C Bank D 200 160 128 102 LOANS 800 640 512 410 DEPOSITS 1000 800 640 512
Bank E
82
328
410
? 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
. ? C(n+1)=.1D(n+1) ? 1.1D(n+1) = .8D ? D(n+1)= .727D ? Total deposits = 909+661+481+… ? 909[.727+(.727)2 +(.727)3 +….] =3330 ? Total Currency = 0.1(3330) =333Balance Sheet of RBI:
? 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)
? 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
ASSETS OF RBI:
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
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
H = Currency + Reserves
? Currency
High Powered Money is held by public and by banks
= vault cash + banks deposits
? Reserves
with RBI = Statutory reserves +excess reserves (FA)+(OA) = ML+NML FA +OA –NML =ML Let NET NML =NML –OA Thus FA- NNML=ML
SOURCES OF CHANGES IN H
? 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
Money multiplier:
? Money
Supply= currency+deposits ? High powered money(H)= Currency + reserves. ? M = C+D M/D = C/D+1 =c+1 H/D = C/D +R/D = c+r
? 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)
? 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
Finance ratios
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.
?
? New
issue ratio: primary issues/ net physical capital formation. It shows the degree of financial disintermediation. (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.
doc_508098134.ppt