Monetary Policy

CURRENT MONETARY POLICY Prepared By: Dr. Himani Singh (IB/27) Prashant Rampuria (IB/29) Sonal (IB/30) Vidisha Singh (IB/31) Babita (IB/32) Indu Madan (IB/34)

WHAT IS MONETARY POLICY? The process by which the central bank or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and

(iii) cost of money or rate of interest,

TYPES OF MONETARY POLICY • Expansionary policy: – Increases the total supply of money in the economy – Involves decreasing the interest rates to pump liquidity in the market. – Government is using since October, 2008

• Contractionary policy: – Decreases the total money supply. – Involves raising interest rates in order to combat inflation. – Government may use in near future.

INFLATION…..

• Inflation moved up to 1.51% for the week ended October 17, 2009 compared with 0.83% for the week ended September 19, 2009. • The RBI has revised its inflation estimate upward to 6.50% at the end of March 2010 from earlier estimate of 5% in the second quarter policy review.

INSTRUMENTS OF MONEATRY POLICY OPEN MARKET OPERATIONS

Bank Rate

NET PURCHASE OF FOREIGN CURRENCY ASSETS

CHANGES IN REPO RATE AND REVERSE REPO RATE

CHANGE IN CRR & SLR

Facts & Figures

OPEN MARKET OPERATIONS….. • RBI undertakes to buy and sell Government Securities from participants in the financial markets. • The operations could be undertaken on an outright basis or repurchase agreements.

Objectives…..  To

absorb or provide liquidity in the market To stabilize inflation To maintain a fixed exchange rate

OPEN MARKET OPERATIONS….. EXPANSIONARY MONETARY POLICY

P U R C H A S E S

S E L L S CONTRACTION MONETARY POLICY

CASH RESERVE RATIO….. The base is the total of the deposits that a bank has. The RBI pays the bank interest on the amount parked with it. Though given up as an indirect instrument, the CRR seeks to impact the level of money supply by affecting the value of the multiplier and is thus on a par with Open Market Operations, currently the preferred monetary tool.

REPURCHASE RATE….. • Repo rate • Discounted interest rate at which a central bank repurchases government securities. • Induction of some of the Short-term liquidity in the system.

REPURCHASE RATE…..

REVERSE REPURCHASE RATE….. • Applicable when a country's reserve borrows money from banks. • Safe proposition. P U R fund shortage money to be P being faced by the taken out of the reserve. economic system. O S E

STATUTORY LIQUIDITY RATIO….. • The amount that the commercial banks require to maintain in the form of – Cash – gold or – govt. approved securities

before providing credit to the customers. • Controls the expansion of bank credit.

BANK RATE….. The Discount Rate The rate of interest which a central bank charges on the loans and advances that it extends to commercial banks and other financial intermediaries

For 1 year or more

FOREIGN CURRENCY ASSET….. • Foreign exchange reserves less gold holdings • Special drawing rights and • India's reserve position in the IMF.

Monetary Policy in an Open Economy Impossible trinity: • Open capital account • Pegged currency regime • Independent monetary policy A country with an open capital account cannot hope to have an independent monetary policy if it runs a pegged exchange rate. Pegging the exchange rate induces a loss of monetary policy autonomy.

Example: • Let us say you have inflation and so want a contractionary monetary policy. • You raise interest rates. • Since the capital account is open, capital flows in from abroad in response to the higher interest rates. • This puts a pressure on the rupee to appreciate.

• The Central Bank buys up the dollars coming in to prevent rupee appreciation. • This leads to an expansion in net foreign exchange assets of the Central Bank and thus of money supply. • Classic symptom of impossible trinity difficulties: raising interest rates but money supply growth is surging. • An expansion in money supply will lower interest rates. • You cannot raise rates, and keep the exchange rate pegged at the same time.

Example: • If the US hikes the Fed rate, and India stays still, capital will flow out and the currency will depreciate. • If the RBI wants to prevent depreciation of the currency, it will have to sell dollars or raise rates. Both these are contradicting. • Currency pegging forces RBI to also raise rates. • Thus having a peg means following US monetary policy.

Summary • Monetary policy is supposed to be about pinning down the short rate so as to achieve an inflation target, and thus stabilise the macro economy. • Pegging the exchange rate induces a loss of monetary policy autonomy. • India’s monetary regime is largely India’s exchange rate regime.

The biggest question today: What is the monetary policy?