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It is concerned with the changing the supply of money

stock and rate of interest for the purpose of stabilizing the economy
at full employment or potential output level by influencing the
level of aggregate demand.
At times of recession monetary policy involves the
adoption of some monetary tools which tends to increase the
money supply and lower interest rate so as to stimulate aggregate
demand in the economy.
At the time of inflation monetary policy seeks to
contract aggregate spending by tightening the money supply or
raising the rate of return.
 To ensure the economic stability at full employment
or potential level of output.

 To achieve price stability by controlling inflation and


deflation.

 To promote and encourage economic growth in the


economy.
 Bank rate policy

 Open market operations

 Changing cash reserve ratio

 Undertaking selective credit controls


 Bank rate is the minimum rate at which the central
bank of a country provides loan to the commercial
bank of the country.

 Bank rate is also called discount rate because bank


provide finance to the commercial bank by
rediscounting the bills of exchange.

 When general bank raises the bank rate, the


commercial bank raises their lending rates, it results
in less borrowings and reduces money supply in the
economy.
 Well organized money market should exist in the
economy. It is not present in India

 It is use full during the times of inflation but it does


not full fill its purpose during the time of recession
or depression.
 It means the purchase and sale of securities by
central bank of the country.

 It is useful for the developed countries.

 The sale of security by the central bank leads to


contraction of credit and purchase there of to credit
expansion.
 When the central bank purchases the securities the cash
reserve of member bank will be increased and vise
versa.

 The bank will expand and contract credit according to


prevailing economic and political circumstances and not
merely with reference to their cash reserves.

 When the commercial bank cash balance increase the


demand for loan and advance should increase. This may
not happen due to economic and political uncertainty.

 The circulation of bank credit should have a constant


velocity.
 The bank have to keep certain amount of bank money
with them selves as reserves against deposits.

 The increase in the cash rate leads to the contraction of


credit only when the banks excess reserves.

 The decrease in the cash rate leads to the expansion of


credit and banks tends to make more available to
borrowers.
Problem: Recession and unemployment
Measures: (1) Central bank buys securities
through open market operation
(2) It reduces cash reserves ratio
(3) It lowers the bank rate
 
Money supply increases
 
Investment increases
 
Aggregate demand increases
 
Aggregate output increases by a
multiple of the increase in
investment
Problem: Inflation
Measures: (1) Central bank sells securities
through open market operation
(2) It raises cash reserve ratio
and statutory liquidity
(3) It raises bank rate
(4) It raises maximum margin against
holding of stocks of goods

Money supply decreases

Interest rate raises


 
Investment expenditure declines
 
Aggregate demand declines
 
Price level falls
 
 Variable time lags concerning the effect of money
supply on the national income.

 Treating Interest rate as the target of monetary policy


for influencing investment demand for stabilizing the
economy.
 Monetary policy and savings.
 Monetary policy and investment.
› Cost of credit..
› Monetary policy and public investment.
› Monetary policy and private investment.
 Allocation of investment funds.
 In recent years starting from the mid-nineties promoting
economic growth is being given greater emphasis in
monetary policy of RBI.
 Three sub-periods:
 Monetary policy of controlled examination(1951-1972).
 Monetary policy in the pre-reforms period(1972-1991) .
 Monetary policy in the post-reforms period(1991-2000).
Reserve bank’s responsibility in the circumstances is
mainly to moderate the expansion of credit and money
supply in such a way as to ensure the legitimate
requirements of industry and trade and curb the use of
credit for unproductive and speculative purposes.
 To ensure controlled expansion, RBI used the instruments:

Changes in bank rate


Changes in cash reserve ratio
Selective credit control
 Price situation worsened during the years of 1972-
1974. to contain inflationary pressures RBI further
tightened its monetary policy.

 It is similar to tight monetary policy.


 Liberal monetary policy adopted for encouraging private
sector since 1996.
 Two instrument for monetary management BY RBI since
1996:
Reactivation of bank rate.
Repo rate system .
 It is introduced through which RBI can add to liquidity in
the banking system. Through repo system RBI buys
securities from the bank and there by provide funds to them.

 Repo refers to agreement for a transaction between RBI


and banks through which RBI supplies funds
immediately against government securities and
simultaneously agree to repurchase the same or similar
securities after a specified time which may be one day
to 14 days.
 It is the another instrument of monetary policy from June
2000 to adjust on a daily basis liquidity in the banking
system.

 Through LAF, RBI regulates short-term interest rates


while its bank rate policy serves as a signaling device for
its interest rate policy in the intermediate period.
 The provision of appropriate liquidity to meet credit growth and
support investment and export demand in the economy while
placing equal emphasis on price stability.
 Consistent with the above pursuit of an interest rate environment
which is conducive to price stability but at the same time it will
maintain the momentum of growth.
 Consideration of measures in a calibrated manner in response to
the evolving circumstances with a view to stabilizing inflationary
pressures.
 These three points is used to meet the requirement of credit for
economic growth and also used to check the inflationary
expectation and inflationary situation that may arise.

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