MONETARY POLICY
Monetary policy refers to those policy masures which are taken by the Contral Bank of a country to control and regulate the supply of money for the realisation of general economic goals, In advanced countries, monetary regulatory role. But in a developing country, like jadla, monetary policy has to play the twin role: promotional and regulatory. That is, monetary policy has to develop and promote banks, money market, arket, stock exchange, etc., and at the same time, control and wyulate the growth of credit by quantitative and qualitative methods. Monetary policy involves changing interest rates, or the money supply in der to influence the economy.
Objectives of Monetary Policy.
The objectives of monetary policy are derived from the objectives of onomic policy. The objectives of monetary policy are:
Price Stability and Inflation Targeting :-
Price stability means stability of the inflation rate at a low rate. Gradual rise in prices is always preferred because that brings an increase in investment, employment and output. Rising prices attract producers to invest more. If prices are rising at a high rate then they should be brought down to stop the inflationary trend. If prices are checked to a great extent then they may lead to fall in the level of production and employment. This may give birth to depression in an economy. To ensure price stability or stability of the inflation rate at a low rate, strong monetary policy is required. The monetary policy does not depend upon Central Bank alone but rather on a large number of commercial banks and unorganised money market.
In case of India, RBI Governor, D. Subbarao gave following reasons for not adhering to inflation targeting (Source : Partha Ray (2013), Monetary Policy):
1. It is not practical for the central bank to focus exclusively on inflation.
2. The drivers of inflation in India often emanate from the supply side which are normally beyond the pale of monetary policy.
3. In India, monetary transmission has been improving but is still a fair bit away from best practice.
2. Exchange Stability or Impossible Trinity.
Partha Ray (2013), in his book Monetary Policy, writes that the monetary policy can achieve any two of the following objectives, but not all three:
(a) An independent monetary policy.
(b) Perfect capital mobility.
(c) A fixed exchange rate. This is termed as the 'Impossible Trinity'.
The impossible trinity reveals the difficulties of managing exchange rates and imposing capital controls simultaneously in a modern economy. Thus, as a former Governor of the RBI put it, if a country accepts complete convertibility, then, 'you either have the choice of giving up monetary independence and setting up a Currency Board or give up the stable currency objective and let the exchange rate float freely so that monetary policy can then be directed to the objectives of inflation control. Partha Ray writes that in reality, various emerging economies sacrifice a bit of each of these objectives to have configuration of the trinity of monetary policy-exchange rate-capital mobility That is to say often a country manages its exchange rate a little bit by sacrificing some of its independence of monetary policy or imposing soe capital controls. The operating phrase in this context is some 'little bit' thereby implying the intermediate stages of t 'impossible trinity.
3. Ensuring Employment.
Monetary policy can help in maintaining the rate of saving ti investment a level which will ensure greater employment loans are made available to the public at cheap rate of interest they will go for heavy investment. This will help in creating more employment opportunities. To achieve success in monetary polics fiscal policy and economic policy should be well integrated.
4. Rapid economic growth and Stabilizing Output.
Rapid economic growth is a long period objective. Monetary Policy ensures adequate flow of money into desirable investment channels uke infrastructure, building basic and key industries.
5. Financial Stability .
It refers to stability in the financial system. It includes:
(1) limited failure of banks.
(2) limited presence of the asset price bubble.
A. Quantitative Instruments.
1. Bank Rate.
It is defined as that rate of interest at which the RBI (Reserve Bank of India) lends to commercial banks. The effect of change in the bank rate is to change the cost of securing funds from of the RBI. In a situation of excess demand, the RBI increases the bank rate or interest rate which makes credit dearer. It discourages people to borrow money from banks. People prefer to deposit in banks. Thus, their purchasing power goes down, which reduces aggregate demand. In a situation of deficient demand, the RBI reduces the bank rate or market interest rate. It makes credit cheaper. It encourages people to borrow money from banks. Since investment is inversely related to rate of interest, a fall in the rate of interest (other things being equal) will raise the investment expenditure.
It is an important instrument used to correct an adverse situation arising out of movement of short term capital.
Limitations of Bank Rate Policy .
Bank rate can be effective only when certain conditions are met. These are.
1. It is essential that there is a well organised money market. It is observed that a large number of indigenous bankers and money lenders, who do not follow changes in the bank rates, constitute a major part of the money market. They reduce the importance of the bank rate policy. In short, bank rate will have more effect if all deposits and payments are made through banks.
2. If interest rate do not respond fully to changes in the bank rate then it will not have much effect.
3. If the degree of flexibility in an economy is high, then the influencs bank rate on price is limited.
4. If price rises as a result of basic scarcity of products, bank rate will fai to bring price down.
5. If firms depend largely on borrowed funds, even for permanent holding. of stocks, bank rate will have more influence in an economy.
2. Open Market Operations (OMO)
It is defined as buying and selling of government securities by the RBI from/to the public or banks. These actions are called open market operations because they take place in the "open market". It does not matter whether the securities are bought or sold to the public or banks because utilimately the amount will be deposited in/or transferred from some banks. In a situation of excess demand, RBỊ sells these eligible securities in its possession to commercial banks so that commercial banks' cash is blocked in them and their capacity to offer loans is 1educed. This is another method to restrict the availability of credit. At present, the liquidity adjustment facility (LAF) combined with OMO emerges as a major tool of liquidity management in the country.
In an expansionary OMO, central bank raises the supply of money.
In an contractionary OMO, central bank decreases the money supply.
Usefulness of OMO.
(a) Open Market Operations make the bank rate policy more etfecte For example, during boom a high bank rate may be accompanied o the sale of securities by the Central Bank.
(b) OMO can be used to bear out seasonal shocks. That is, securities be bought during the busy season and sold during the slack season.
(c) OMO helps in stabilising the prices of securities. This is done by purchasing them when their prices are low and selling them when their prices are more.
Limitations of OMO.
(a) OMO is effective only when it is used along with other instruments
(b).The effectiveness of OMO is reduced by hoarding or dishoarding of money.
(c) OMO effectiveness is based on the assumption that commercial banks will always increase or decrease their loans and investment in accordance with increase or decrease in their cash reserves. This may not hold in reality as credit expansion depends upon business psychology and moods.
1 Cash Reserve Ratio (CRR):
It is defined as that portion of total deposits which a commercial bank is required to keep with the RBI in the form of cash reserves. It implies that every commercial bank has to keep some specified cash reserves ratio of its total deposits with the RBI. In a situation of excess demand, RBI raises the CRR. This will reduce the cash deposits left with commercial banks to be loaned out. This is another method to control the availability of credit. During depression or deficient demand situation, RBI reduces the CRR. The result of reducing the CRR will obviously be seen in the surplus cash reserves with bankS which can be offered for credit. Bank's credit creation power increases.
4. Statutory Liquidity Ratio (SLR):
It is defined as that portion of total deposits which a commercial bank has to keep with itself in the form of liquid assets. In a situation of excess demand, RBI raises the SLR. The result is reduction in surplus cash reserves of commercial banks which can be offered for credit. This will discourage credit in an economy. RBI reduces SLR in a situation of deficit demand. This will have an expansionary effect on the credit position of banks.
5. Repo Rate (RR):
It is the rate at which the Central Bank pumps in short-term liquidity into the system.
6. Reverse Repo Rate (RRR):
Is the rate at which banks put their short-term excess liquidity with the Central Bank in exchange for investment securities.
B. Qualitative or Selective Instruments.
These instruments allow credit in priority sectors only. The main selective credit control method to correct the credit position are:
1. Marginal Requirement
Margin is defined as the difference between the value of security and the amount borrowed against that security. RBI can fix different marsi requirements for different uses such that credit is diverted into ess sectors only. In a situation of excess demand, RBI raises the marginal requirement. It implies that borrowers will get less credit against the securities. So, it will impose a restraint upon borrowers and thus, keep dows the volume of credit. It also discourages speculative activities with bank cred and thus, diverts resources from unproductive activities to productive investments. Marginal requirements are reduced in a situation of deficient demand. implies that borrowers will get more credit against their securities. It will encourage borrowing. The following are the other restrictions which are imposed on credit under qualitative method:
(a) An overall ceiling on loans and advances made by commercial banks can be fixed.
(b) An overall ceiling on loans and advances made by a bank to any borrower can be fixed.
(c) Purposes for which no loan shall be advanced by any bank can be fixed.
(d) Different margin requirements for different uses can be fixed by RBI.
(e) Different rates of interest and different conditions for different purposes can be fixed.
(f) The banks can be prohibited from entering into certain transaction by the RBI.
2. Moral Suasion
The word "Suasion" literally means persuation on moral ground, wi implied force. In this technique, the RBI issues letters to the banks encourag them to exercise their control over credit and grant loans for essentinl purposes only and not for speculative purposes. It is a very useful method of restricting availability of credit in a situation of excess demand in he During depression. the RBI issues instructions to member banks to increa the availability of credit to borrowers for non-essential purposes also.
QUALITIES OF GOOD MONEY
Good money facilitates the working of an economic system. It acts as an for promoting and accelerating economic growth. Money should possess certain qualities. These are:
(1) Universal acceptability. Money must be easy to recognise and familiar to use to most of the people.
2 Portable. Material used in coins and paper money should not be heavy. Also, it should not be so tiny as to cause loss due to misplacement. Money should be made from such commodities which can be easily carried from one place to another. It should contain large value in small bulk.
3. Cognizable. The colour, form, size of money should be such that it can be recognised by all.
4. Divisibility. Money must be easily divisible into various.
5. Homogeneity. It means all units of money should be of same value.
6. Stability of value. Money can perform its function well if its value or purchasing power is stable. If it is unstable, it will lead to loss of confidence of people is money.
7. Elasticity. Money should be made of such a commodity supply of which is elastic, i.e., the supply can be increased easily whenever there is a need.
DEFECTS OF MONEY
It has been rightly said that 'Money is a good servant but a bad master. Defects of money are:
1. Money is the main cause of prevailing grave inequalities in the distribution of income and wealth.
2. Boom and depression are economic evils which bring about economic instability. These exist due to frequent changes in the value of money.
3. Money promotes concentration of economic power and monopolis- tic tendencies.
4. Money is the main cause of all social evils like murder, dowry, deception, betrayal etc.
5.According to Robertson, "Money which is the source of so many blessings to mankind becomes also, unless controlled, source of destruction and confusion".
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