s7m monetary policy

1Monetary Policy of RBI

www.rbi.org.inMacro

econ

omic

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Monetary PolicyOutline:

Objectives of Monetary PolicyTypes of Monetary PolicyInstruments of Monetary Policy and their MechanismMonetary Policy Framework of Central BankLAF, MSS, MSFThe Transmission Mechanism,Recent Monetary Policy

2MonetaryPolicy:Definitions,ObjectivesandTypes

RBI was established on April 1, 1935 with RBI Act 1934, therecommendations of HiltonYoung Commission. It wasnationalized in 1949.

Main Role of RBI

1. Supply of Money to the Economy

2. Lender of Last Resort

3. Regulator of Financial system

4. Financial advisor to State Governments

Monetary Policy: RBI

3Monetary Policy: Making Process in IndiaHeadedby

TheRBIGovernorAssistedby

TheRBIDeputyGovernorsGuidedby

TheBoardofDirectors SeveralStandingCommitteesorGroupsoftheBoard TechnicalAdvisoryCommitteesandStandingCommittees AdhocWorkingGroups BoardofFinancialSupervision

FormulatesMonetaryPolicyoncein6month.1.AprilSeptember :SlackSeasonPolicy2.October March :BusinessSeasonPolicy

ReviewthesameonquarterlybasisLAFandMSSdonedailybasisduringtheofficehrs.

Monetary Policy is essentially a program of action undertakenby the monetary authorities, generally the Central Bank, tocontrol and regulate the cost and supply of money andcredit with the public with a view to achieving predeterminedmacroeconomic goals.

Monetary Policy: Meaning Monetary

Policy

Involves Policies

That influences the cost(interest rate )

and availability of money and credit.

4Monetary Policy: Objectives

Expansionary ( Easy) Policy

AimEncouraging spending on goods and services by expanding supply of credit and money.

Tools Lowering the Policy Rate

(bank rate or repo rate)

Lowering the reserve requirements ( CRR, SLR)

Purchasing the Govt. securities from the market

Contractionary ( Tight) Policy

AimPreventing Inflation by contracting the Money Supply.

Tools Increasing the Policy Rate

(bank rate or repo rate)

Increasing the reserve requirements ( CRR, SLR)

Selling the Govt. securities from the market

Monetary Policy: Types

5Monetary Policy: Types

Monetary Policy: Types

6MonetaryPolicy:OperatingFrameworkandInstruments

Monetary Policy: Operating Framework

7 Refers to the tactical decision on or daily implementation of monetary policy

Covers the choice of Policy instruments

Operating target

Width a corridor for market interest rates

Nature, extents and frequency of different market operations

The manner of signaling policy intentions

Monetary Policy: Operating Framework Operating Procedure

Monetary Policy: Operating Framework

Instruments Suchas,bankrate,reporate,CRR,SLR,OMOetc.

OperatingTarget

ReservesAggregates:suchasBankReserves(=borrowed+nonborrowedreserves),monetarybase(M0).

ShortTermmoneyMktInterestRates:likeinterbankrate,Treasurybillrate

IntermediateTarget

MonetaryAggregatessuchasM1,M2,M3 CreditAggregate MultipleTarget:InterestRate,Inflationrate,

assetsprices,ExchangeRate,fiscaldeficitetc.

FinalGoal GDP, Inflation Unemployment

8Monetary Policy: Instruments

Statutory Liquidity Ratio(SLR)

Affects the total volume of credit by influencing the credit creating capacity of the commercial banks

1.Bank Rate Is the minimum rate at which the Central Bank of a country lends

money to banks and financial institutions against the govt. andother approved securities .

Bank Rate is also known as discount rate, where rediscountedeligible bills of exchange or commercial paper. Not so welldeveloped in India. RBI, NABARD, SIDBI discounts bills ofexchange.

BR is Bank rate, FBR is Funds Borrowed by Banks, CR is Credit, MSis Money Supply

Monetary Policy: 1. Quantitative Instruments

BR FBR CR MS

As of today 15/ 11/2015. Bank rate is 7.75 %

9Bill Rediscounting

2. Cash Reserve Ratio (CRR) All scheduled & nonscheduled commercial banks (i.e. public & private

sector, foreign banks, urban co-operative banks, Regional rural banks )are required to hold as reserves either in cash or as deposits with RBI, someamount of their total of Net Demand and Time Liabilities (NDTL), on afortnightly basis. The amount of which shall not be less than 4% or greaterthan 20% of the their NDTL.

They are required to maintain minimum CRR balances upto 70 per cent of thetotal CRR requirement on all days of the fortnight with effect from thefortnight beginning December 28, 2002.

(RR- required reserve, ER- excess reserve, CR- credit,)(Excess reserve means in an above CRR & SLR, to meet unforeseen withdrawal) CRR rule doesn't apply to Non Banking Financial Companies (NBFC),

Mutual funds or Insurance Companies


As of today 15/ 11/2015. CRR is 4%

CRR RR ERCR MS

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3.Statutory Liquidity ratio (SLR) SLR is that amount which a commercial bank has to

maintain with RBI in the form of cash, gold or approvedGovt. securities. SLR should lies in between 22-40%.

The quantum is specified as some percentage of the total ofNet Demand and Time Liabilities(NDTL) of a bank.

This percentage is fixed by RBI. The date which is taken tocalculate the demand and time liabilities of the bank is thelast Friday of the preceding fortnight.

SLR is maintained on daily basis.


As of today 15/ 11/2015. SLR is 21.5%

4. Open Market Operations=>Sale and purchase of a variety of asset such as foreign exchange, gold, govt securities by the central bank

a. Out right OMO- The outright sale of any of the assets by the Central bank from its own

account leads to absorption of the liquidity and reduction in money supply from the market forever by impounding the resources of financial institutions in these securities

- The outright purchase implies Injections of the liquidity

BR-banks reserve, GS Govt Securitiesb. Repo or reverse repo operation

It is a contract in which a participants acquires funds by selling the securities , such as treasury bills, and simultaneously agrees to buy them back or repurchase the same at a specified time and price/repo rate.


As of today 15/ 11/2015. Repo Rate is 6.75 and Reverse Repo is 5.75%

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Affects the types of credit extended by the banks affect the composition of bank portfolio.

Monetary Policy: 2. Qualitative Instruments

Monetary Policy: 2. Qualitative Instruments

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Repo CPI

Inflation vs interest rates since 2010

MonetaryPolicy:OperatingProcedureinIndia:LAF,MSSandMSF

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Objective: PriceStability(P) Financialstability(F) EmploymentGrowth(E) RealoutputGrowth(Y)

IntermediateTarget: Credit,moneysupply, Multipletargetsuchasinterestrate,

exchangerate,fiscaldeficit,inflationrateetc.Instruments:

Preindependence:bankrate,OMO 1970s:CRR,SLR,OMO 1990s:Directtoindirect,repo,reverserepo 2000s:EmergenceofLAF,MSS,MSF

Monetary Policy: Objective, Target and Instruments in India

MonetaryPolicy TargetMarketVariable LongTermObjectiveCreditAggregates

Thegrowthofcreditinthebankingsector,priority sectorlending

Growthrate ofoutputandpricelevel

MonetaryAggregates

Thegrowthinmoneysupply(Mo,M1, M3 etc.)

AgivelevelofchangeinCPI

GoldStandard Thespotpriceofgold Lowinflationmeasuredbygoldprice

Exchange RateTargeting

Thespotpriceofthecurrency Thespotpriceofthecurrency

MultipleIndicatorApproach

Usuallyinterestrate alongwithfiscaldeficit,tradedeficit,inflationrate,exchangerateetc.

Price stability,financialstability,unemploymentrate

InflationTargeting

Interestrateonovernightdebt AgivenrateofchangeinCPI,WPI

Monetary Policy: Regimes in General

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Year MPObjectives IntermediateTarget

Instrumentsandsteps

19301950

Regulates demandandsupplyofcredit

Credit Aggregates Bankrate, ReserveRequirements,OMO

1950s PstabilitywithGrowth BankratechiefInstruments, Money&Creditimportantfordev.

1960s Price StabilitywithGrowth

BankRate,Prioritysectorlending,banknationalization,

1970s Price Stability MonetaryTargeting(Mo,M1, M3etc)

IncreaseinM0,Monetaryexpansion,CRR,SLR,OMO

1980s Pstability,growth,employment:

Creditimportant,CRR,SLR is regulated,interestratederegulated,ChakravartyCommitteeReport(1985)workingofMonetarySystem

1990s PandFinancialStability,(liberalizationandglobalizationpolicy,automatic monetizationoffiscaldeficitremoved)

ShiftfromdirecttoIndirectInstrumentsMultipleIndicatorApproach,suchasinterestrate,exchangerate,fiscaldeficit,inflationrate

ShortterminterestratesuchasBankrate,reporate,OMO,moreflexibilityinthe operatingsystem(NarasimhamCommitteeReportonBankingSectorrecommendedLAF(1998)andMSS

2000s PandFinancialStability,Growth LAF,MSS:reporate,reversereporateetc.

2010 P stability,growthandemployment

ThinkingofInflationTargeting

LAFandMSF:reporate,reversereporate,MSFrateetc.

Monetary Policy: Evolution of Objective & Operating Procedure in India Decadewise

What is LAF ? LAF is a facility to inject and absorb liquidity on short term basis to evenout themismatch between D & S in short-term funds. Operates through repo rate, reverse repo rate which provide a corridor for the callmoney rate and other short term interest rates, supported by OMO.

What is Liquidity ?(i) Macroeconomics: Extent of mismatch bt. D & S of Money Supply; overall monetary conditions(ii) Finance: ease of undertaking financial assets; bid- ask spread(iii) Central bank: Monetary base (C+R)

Repo- repurchase agreement:- An agreement involving the sale of securities by one party to another (by banks to RBI) with a promise to repurchase the securities at a specified price on a specified date. Injection of liquidity Reverse Repo- reverse repurchase agreement:-Involves the purchase of securities between parties (by banks from RBI) with promise to sell them back at a given date in the future. Absorption of Liquidity.

Collateralized borrowing and lending (e.g.-T-Bills , etc) Call Money Rate- Short-tem funds transfer between FIs-Inter bank rate

No collateral

MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)

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LAF was introduced to Do away with the deficiencies of refinance system Multiplicity of the rates at which liquidity was made available The funds under LAF to be used by the banks for their day-to-day mismatches in liquidityObjective of LAF

i. Provision of adequate credit for growth and investment with price stability ii. Phasing out of non-bank financial intermediaries from call market. (Aug 6,2005) and make call money market as pure interbank market,iii. Send policy signals and influence the interest rates in other financial market iv. Try to keep call money rate in between repo and reverse repo rate.


Graph of Overnight Cash RatesCha rt-5: Movement of Call Mone y Rate and LAF Corridor

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MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)Graph of Overnight Cash Rates

Fist Phase began on June 5, 2000 ACLF and Level-II support to PDs was replaced by variable repo auctions with same

day settlements CLF and ECR for banks and Level-I to PDs was replaced by variable rate auctions (

May 2001) CLF was withdrawn in October 2002Second Phase March 29, 2004 a revised LAF scheme was operationalized The repo rate was reduced to 6.percent and unified to the Bank Rate. The 1-day reverse repo was phased out, and in its place the 7-day fixed rate reverse

repo on a daily basis and the 14-day variable rate reverse repo on a fortnightly basis were introduced. But RBI reintroduced the 1- day fixed rate reverse repo in August 2004 while continuing others two as usual.

Oct 29, 2004 repo and reverse repo renamed as per international usage.Third Phase Full-fledged LAF began with the full computerization of the Public Debt Office (PDO)

and the introduction of the Real Time Gross Settlement (RTGS) Repo auctions are now mainly carried out through electronic transfer Full fledged LAF is an essential tool for adjusting marginal liquidity not total liquidity

MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)Full-fledged LAF Introduced in Three phases

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MPOperatingProcedure:LiquidityAdjustmentFacility(LAF)Modus Operandi of LAF

Tenor:Underthescheme,ReverseRepoauctions(forabsorption)andRepoauctions(forinjection)areconductedonadailybasis(exceptSaturdays).

MinimumbidSize :Rs.5crandinmultipleofRs.5cr Eligiblesecurities: ReposandReverseReposintransferableCentralGovt.

datedsecuritiesandtreasurybills. MajorPlayers

Banks:Allcommercialbanks(exceptRRBs)havingsubstantialTreasuryBills,Central/StateGovernmentsecuritiesapprovedbyRBI

PrimaryDealershavingcurrentaccountandSecurityGeneral Ledger(SGL)accountwithRBI

DiscountandFinanceHouseofIndia(DFHI):EstinApril1988.ItisanauthorizedinstitutionbyRBItoundertakerepotransactions(bothbuyingandselling)intreasurybillsandalleligibledatedgovernmentsecuritiestoimpartgreaterliquiditytotheseinstruments.SinceNovember13,1995,DFHIisanaccreditedprimarydealer

Modus Operandi of LAFMPOperatingProcedure:LiquidityAdjustmentFacility(LAF)

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MOU signed between GOI and RBI on MSS on March 25, 2004 MSS is Operational since April 1, 2004. Absorb excess liquidity in the market which might arises due to

heavy inflow of foreign capital (FII) through both Govt TreasuryBills and dated Govt. Securities (Adhoc treasury bills) on dailybasis.

Unlike OMO, under MSS the govt securities are not owned byRBI. The GOI issue T Bills and or dated securities under theMSS in addition to its normal borrowing to absorb liquidity fromthe system.

Sale of these securities are held under MSS account

MPOperatingProcedure:MarketStabilizationScheme(MSS)MarketStabilizationScheme(MSS)

Table 1: Reserve Banks Liquidity Management Operations: Annual Variations (` billion)Item 2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

2009-10

2010-11

2011-12

A. Autonomous Drivers of Liquidity (1+2+3+4) 425 941 797 -3131,232 3,046 -1,668 -1,008 -1,111 -2,6361 RBIs net Purchase from Authorised Dealers 7901,406 911 3291,190 3,121 -1,786 -120 76 -1,0452 Currency with the Public -308 -434 -413 -558 -707 -856 -970 -1,020 -1,443 -1,1483 Cash balances of the Centre with the Reserve Bank -36 -178 5 -227 -12 -266 604 -20 18 -5764 Others (residual)$ -21 147 294 143 761 1,047 484 152 238 133B. Management of Liquidity (5+6+7+8) -414 -754 -608 579 -301 -1,253 2,352 1,322 1,756 2,7945 Liquidity impact of LAF Repos 24 -371 153 121 364 212 -518 5 1,070 5796 Liquidity impact of OMO (net) * -538 -418 -29 107 -51 59 1,045 824 784 1,4207 Liquidity impact of MSS 0 0 -642 351 -339 -1,054 803 853 27 08 First round liquidity impact due to CRR change 100 35 -90 0 -275 -470 1,023 -360 -125 795C. Bank Reserves # (A+B) 11 187 189 266 931 1,793 684 314 645 158(+): Injection of liquidity into the banking system. (-): Absorption of liquidity from the banking system.$: Includes standing facilities, etc.*: Includes oil bonds but excludes purchase of government securities on behalf of state governments.#: Includes vault cash with banks and adjusted for first round liquidity impact due to CRR change.Note: Data pertain to March 31.

Monetary Policy: RBIs Liquidity Management

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1. The weighted average overnight call money rate was explicitly recognized as theoperating target of MP. Repo rate was made the only one independently varyingpolicy rate.

2. A new Marginal Standing Facility ( MSF) was introduced since May 9, 2011,under which scheduled commercial banks could borrow overnight at their discretionup to 1% (2% (wef 17/4/2012))of their NDTL outstanding at the end of the secondpreceding fortnight at 100 basis point above the repo. But for the interveningholidays, the MSF facility will be for one day except on Fridays when the facilitywill be for three days or more, maturing on the following working day. In the event,the banks SLR holdings fall below the statutory requirement up to one per cent oftheir NDTL, banks will not have the obligation to seek a specific waiver for defaultin SLR compliance arising out of use of this facility .

3. The Facility will be available on all working days in Mumbai, excluding Saturdaysbetween 3.30 P.M. and 4.30 P.M.

As of today 15/ 11/2015. MSF Rate is 7.75%

MPOperatingProcedure:MarginalStandingFacility(MSF)MarginalStandingFacility(MSF)

4. Revised corridor is fixed with 200 basis point at which lower corridor is reverse repoand upper one is MSF rate and mid one is repo rate.

MPOperatingProcedure:MarginalStandingFacility(MSF)

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MPOperatingProcedure:Marginal StandingFacility(MSF)

MPOperatingProcedure:Marginal StandingFacility(MSF)

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Monetary Policy: LAF and MSF

LAF MSFLiquidityadjustmentfacility MarginalstandingfacilityMinimumbiddingamountis5cr. 1cr.AllclientsofRBIareeligibletobid. Onlyscheduledcommercialbankscanbid.BankcannotsellGovernment securitytoRBIthatispartofbanksSLRquota.

BankcanselltheGovernmentsecurityfromitsSLRquotatoRBI.

Bankcanborrowanyamountofmoneyaslongasithasthesecuritiestosell.

Bankcanmaximumborrowupto 2%ofitsNDTL.

Supposereporateisr% MSFlendingrateisalways(r+1)%

Monetary Policy: Difference Between LAF and MSF

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MonetaryPolicyandEconomicActivity:

Meaning: the general conceptual framework within which theanalysis of monetary policy disturbance may be undertaken isknown as MPTM, whereas the routes through which thisdisturbance influence goal variables (real economy) are itschannel.

Types: money supply, interest rate, other assets price, credit and uncertainty and expectations.

Monetary Policy and Economic Activity

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Monetary Policy: How its works ( Keynesian View)

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i) M Peadverse selection and moral hazardlending I Yii)M i net cash flowadverse selection and moral hazard Lending I Y.

Balance sheet channel

i) M * C Y,ii) M R* I Y, Uncertainty and expectations channel

5. Uncertainty and Expectations Mechanism

M bank depositsbank loans I YBank Lending channel4. Credit Mechanism

(i) M housing and land prices q I Yii)Mhousing and land priceswealth C YReal assets price channel

M e Pe I Y , Stock market channel

M Portfolio liquidity Likelihood of financial distress Consumer durable spending Y.Liquidity channel

M Portfolio liquidity Likelihood of financial distress Consumer durable spending Y. Net worth channelM PeW C I YWealth effect

M Pe q I Y , Tobins q theory Equity price

M r E TI YExchange rate3. Assets Price Mechanism

i) M r I Yii) M r C Yiii) M rC I Y

Interest rate channel 2. Interest Rate Mechanism

M YMoney supply channel1. Money Supply Mechanism

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Monetary Transmission Mechanism in IndiaUpto 1980s : both money supply and creditSince 1989 : Interest rateAfter 1990s : Financial sector Reforms

: multiple channel: interest rate channel,exchange rate channel and other assets price channel become prominent.

Shifts in instruments from direct to indirect, Bank rate, CRR, SLR, OMO loosed efficiency

Monetary Policy and Economic Activity

DomesticEconomy: GDPGrowth:duetopersistenceweaknessinindustrialactivityacross

Globe,RBIdownsidestheGDPgrowthprojectionfrom5.7%to5.5%. Inflation:HeadlineWPIinflationtargetassetbyTheRBItobeachieved

byMarch2014as5% CurrentAccountDeficit201213is4.8%wellabovethesustainedlevelof

2.5%ofGDPestimatedbytheRBIMonetaryMeasures ReporateunderLAFremainedunchangedat7.25% Reversereporate,determinedwithaspreadof100basispointtobe

remainedunchangedat6.25% TheMSFrateremainsunchangedat30basispintabovethereporateat

10.25% Thebankrateremainedat10.25% TheCRRhastoberetainedat4.00%ofNDTL SLRtoberetainedta23.00%

Monetary Policy Review Q1 2013-14

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RBIGovernorsandTheirMonetaryPolicyP:AGlimpse R.N. Malhotra(1985-1990) Develop money market, set up National Housing

Bank, catalyze the flow of credit through commercial banks S Venkitramanan(1990-1992) adopt IMF stabilization program, Rupee being

devalued, launch the program of economic reforms, Dr C Rangarajan(1992-1997) introduction of new institutions and instruments,

establishing unified exchange rate , historic memo- between banks and govt -cap-adhoc treasury bills, stop automatic monetization of FD, W& M advance.

Dr Bimal Jalan (1997-2003): India weathering Asian crisis, improving transparency and central bank communications, strengthening BOP and FOREX, Low inflations and soft Interest rates

Dr Y V Reddy(2003-2008): made significant policy contributions in the areas of financial sector reforms; trade finance; monitoring of balance of payments and exchange rate; external commercial borrowings; centre-state financial relations; regional planning; and public enterprise reform and has been closely associated with institution building.

Dr. D Subbarao (2008-2013): post crisis period quite challenging, reduced repo rate several times, highly criticized by MOF, rupee depreciation, high inflation, high current A/C deficit, week investment environment.

Dr Raghuram Rajan(2013) inclusive growth and development with financial stability, more banks in rural area, new bank licenses, increased repo rate,

inflation targeting

Monetary Policy: Making Process in India

Role of RBI during Recession

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Business Cycle: RecessionEconomy typically expands for 6-10 years and tends to go into a recession for aboutsix months to 2 years called as Business cycle

RBIs measures during III QUARTER OF 2007-09

All the Interest rate has been reduced

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RBI Announces Further Monetary Stimulus Date : 02 Jan 2009

Inareviewofcurrentglobalanddomesticmacroeconomicsituation,theReserveBankhasdecidedtotakethefollowingfurthermeasures:RepoRate Toreducethereporateundertheliquidityadjustmentfacility(LAF) by100basispointsfrom6.5percentto5.5percentwithimmediateeffect.

Reverse RepoRate ToreducethereversereporateundertheLAFby100basispoints from5.0percentto4.0percentwithimmediateeffect.

RBI Announces Further Monetary Stimulus Date : 02 Jan 2009

CashReserveRatio Toreducethecashreserveratio(CRR)ofscheduledbanksby50basis

pointsfrom5.5percentto5.0percentfromthefortnightbeginningJanuary17,2009.

ThereductionintheCRRwillinjectadditionalliquidityofaroundRs.20,000crore tothefinancialsystem.Itisexpected thatthereductioninthepolicyinterestratesandtheCRRwillfurther enablebankstoprovidecreditforproductivepurposesatappropriateinterestrates.TheReserveBankonitspartwouldcontinuetomaintainacomfortableliquiditypositioninthesystem.

Thefundamentalsofoureconomycontinuetobestrong.Oncethecrisisisbehindus,andcalmandconfidencearerestoredintheglobalmarkets,economicactivityinIndiawouldrecoversharply.Butaperiodofpainfuladjustmentisinevitable.

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How India Avoided Recession of 2007-091. Domestic Economy:

Indian economy is mostly domestically driven. Not so much exposed to export and import.

Indias relatively low level of exports21 percent of GDPhas insulated the country from the impact of the global recession

2. Banking Sector State-dominated banking sector and low risk appetite. Today the

countrys banks are 75 percent government owned.3. External Sector

Government control on Capital Flow. Full capital account convertibility but not current account.

4. Stock Market Regulation tougher When the market was booming with voluminous funds from foreign

investors, SEBI imposed tougher rules to limit and to regulate the funds.5. Fiscal Measures

India practiced austerity measures to check fiscal deficit and current account deficit to keep debts low

6. Monetary Measures : Corrective measures adopted by RBI Interest Rates

RBI first lowered the interest rates to boost demand or spending during economic slowdown, CRR, SLR , repo, revere repo were lowered,

Later on to manage inflation and promote growth RBI raised interest rates. Sub-Prme Loans:

RBI tighten the credit especially housing loans, when property prices wasshooting up very high

RBI didn't encourage sub-prime loans. Mortgages were issued based on justthe borrower's income.

Loan Provision: When the land values were rising in India, then RBI governor Y.V.Reddy

ordered the banks to stop issuing loans to raw lands. Without this ban,India would have got trapped in the bubble with its rising middle class income.

Loan amount were released to the customers only after the developmentwork was started.

Indian banks were tempted heavily by the securitization method adopted by theUS banks for funding money. But, the RBI governor was strict in rejecting themodel. The Indian bankers who were critical of Reddy's tougher rules, laterrealized the reason behind the decisions.

How India Avoided Recession of 2007-09

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Most central banks have adopted an inflation rate target rather than a nominal money growth rate target.

They think about short-run monetary policy in terms of movements in the nominal interest rate rather than in terms of movements in the rate of nominal money growth.

The Design of Monetary PolicyMonetary Targeting VS Inflation Targeting

Untilthe1990s,monetarypolicy,intheUSandotherOECDcountries,wastypicallyconductedasfollows:

Thecentralbankchoseatargetratefornominalmoneygrowthcorrespondingtotheinflationrateitwantedtoachieveinthemediumrun.

Intheshortrun,thecentralbankallowedfordeviationsofnominalmoneygrowthfromthetarget.

Tocommunicatetothepublicbothwhatitwantedtoachieveinthemediumrunandwhatitintendedtodointheshortrun,thecentralbankannouncedarangefortherateofnominalmoneygrowth.

Money Growth Targets and Target RangesThe Design of Monetary Policy

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There is no tight relation between M1 growth and inflationnot even in the medium run, because of shifts in the demand for money.When people reduce their bank account balances and move to money market funds, there is a negative shift in the demand for money.Frequent and large shifts in money demand created serious problems for central banks.

M1 Growth and Inflation: 10-Year Averages since 1970

The Design of Monetary PolicyMoney Growth Targets and Target Ranges

In many countries, central banks have defined as their primary goal the achievement of a low inflation rate, both in the short run and in the medium run. This is known as inflation targeting.

Trying to achieve a given inflation target in the medium runwould seem a clear improvement over trying to achieve a nominal money growth target.

Trying to achieve a given inflation target in the short runwould appear to be much more controversial.

Inflation TargetingThe Design of Monetary Policy

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The result that we have seen that inflation targetingeliminates deviations of output from its natural level istoo strong, however, for two reasons:

The central bank cannot always achieve the rate ofinflation it wants in the short run.

Like all other macroeconomic relations, the Phillipscurve relation does not hold exactly.

The Design of Monetary PolicyInflation Targeting

Implication for Business Monetary Policy aimed at regulating the cost and availability of credit, which is an Important determinant of the levels of investment.

Changes in bank rate, repo rate, reverse repo rate affects the cost of credit, funds.Changes in CRR, SLR affects the availability of credit/ funds.

Expansionary Monetary Policy- injection of money in to the system leads easy availability of credit,

Contractionary Monetary Policy reversePriority Sectors such as agricultural credit exporters, small scale industry etc. look for MP announcement for respective packages facilityMP changes has also affects stock market. Easy MP boost market sentiments, increases the trading volumes, helps raising finances for the corporates from the market. Flexible exchange rate regime and open economy framework of MP affects exchange rate. Expansionary MP reduces int rate which reduces exchange rate, Knowledge of MTM helps the managers to assess and predict the impact of MP on the economy , the financial positions which helps them in adjusting their production and planning process.

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Thank You All

s7m monetary policy

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