Monetary policy,objectives, instruments of credit control and transmission mechanism of monetary policy

1. Monetary Policy
Sonam Sangwan
Assistant Professor, Economics
GCW Bawani Khera

2. What is Monetary Policy?
 Monetary policy is an economic policy that manages the size and
growth rate of the money supply in an economy.
 Monetary policy refers to changes made by a central bank to interest
rates and/or the quantity of money in order to achieve changes in
aggregate demand that keep inflation within its target range.
 Monetary policy determines the amount of money that flows through
the economy.

3. Objectives of Monetary Policy
 Full Employment: full employment refers to the situation wherein all persons
who are able to work and willing to work at the prevailing rate of wage,get
work.
Cheap monetary policy→ low rate of interest → expand availability of credit
 Economic Growth: Economic growth refers to the process of sustained rise in
real income per capita.
Accordingly the govt. Adopts a monetary policy to accelerate the rate of capital
formation which in turn increase production capacity and so level of income.
 Price stability: Means control of wide fluctuations in the general price level in
the economy. Monetary policy seeks to eradicate both inflationary as well as
deflationary tendencies in the system.
 Exchange stability: Stability of BOP (Monetary Policy seeks to regulate foreign
exchange reserves in order to control demand and supply parameters)
 Reduction in Economic inequality

4. Parameters of Monetary Policy
 Supply of Money: Supply of money refers to the currency
issued by the monetary authority and the demand deposits
with the commercial banks.
 Rate of interest: Rate of interest is generally sought to be
raised during inflation when Expenditure needs to be
curbed and it is lowered during depression with a view to
increasing the availability of credit.
 Availability of Money: Availability not money refers to
credit control. It is defined as the ease with which at any
given rate of interest, money can be borrowed from
financial institutions.

5. Instruments of Credit Control
Quantitative
method
Qualitative
method
Methods of
credit
control

6. Quantitative Controls
The quantitative or general credit control methods adopted by the RBI directly
influence the total volume of credit in the economy and also the cost of credit (
rate of interest).
The instruments available with the RBI for this method are:
 Bank rate: It is the rate at which central bank (RBI) lends money to
commercial banks by discounting bills of exchange.When the supply of credit
increased by commercial banks, it creates inflation and increases the price of
necessities. To control such condition central bank increases the bank rate.
 Open Market Operations: Open Market Operation implies deliberate direct
sales and purchase of securities. The Central Bank sells the securities in the
open market to decrease the money supply of the banks.OMO lead to
expansion of credit when RBI buys securities.
 Cash Reserve Ratio (CRR): The Cash Reserve Ratio (CRR) is an effective
instrument of credit control. Under the RBl Act of, l934 every commercial
bank has to keep certain minimum cash reserves with RBI. The RBI is
empowered to vary the CRR between 3% and 15%. A high CRR reduces the cash
for lending and a low CRR increases the cash for lending.

7. Quantitative Controls
 Statutory Liquidity Ratio (SLR): Under SLR, the
government has imposed an obligation on the banks to;
maintain a certain ratio to its total deposits with RBI in
the form of liquid assets like cash, gold and other
securities. The RBI has power to fix SLR in the range of
25% and 40%.
 Credit Control Function: Commercial bank in the country
creates credit according to the demand in the economy.
But if this credit creation is unchecked or unregulated
then it leads the economy into inflationary or deflationary
cycles.Thus central bank regulates the credit creation
capacity of commercial banks by using various credit
control tools.

8. Qualitative Controls
The qualitative or selective credit control techniques are employed by
the RBI to control the direction and use of credit rather than the volume
of credit.The selective credit control methods employed by the RBI
include:
 Margin Requirements: The commercial banks generally advance loans
to their customers against some security.More generally, the
commercial banks do not lend upto the full amount of the security but
lend an amount less than its value. A rise in the margin requirements
by RBI results in a contraction in the borrowing value of the security
and similarly, a fall in the margin requirements results in expansion in
the borrowing value of the security.
 Credit Rationing: Rationing of credit is a method by which the Central
Bank seeks to limit the maximum amount of loans and advances and,
also in certain cases, fix ceiling for specific categories of loans and
advances.

9. Qualitative Controls
 Moral Suasion: Under Moral Suasion, RBI issues periodical
letters to bank to exercise control over credit in general
or advances against particular commodities. The policy of
moral suasion will succeed only if the Reserve Bank is
strong enough to influence the commercial banks
 Direct Action: It is too severe and is therefore rarely
followed. It may involve refusal by RBI to rediscount bills
or cancellation of license, if the bank has failed to comply
with the directives of RBI.

10. Monetary Policy as instrument to combat
inflation:
 Restraint on New currency
 Increase in rate of interest
 Credit control
 Demonetization

11. Monetary policy as an instrument to
combat deflation:
 Increase in Supply of money
 Reduction in rate of interest
 Easy availability of credit

12. Monetary policy and stability of
exchange rate:
 The parameter of supply of money:
If imports>exports⟹exchange rate unfavorable⟹supply of money⬇⟹domestic
price ⬇⟹exports ⬆and imports ⬇⟹exchange rate will improve.
 The parameter of cost of money:
If imports>exports⟹rate of interest⬇⟹domestic and foreign investment ⬆
⟹exchange rate improves.
 The parameter of availability of money:
If imports>exports⟹exchange rate unfavorable⟹availability of credit to
exporters is facilitated⟹encourage exports⟹exchange rate improves.

13. Monetary policy and Economic
Development:
 Mobilisation of savings
 Capital formation
 Price stability
 Utilisation of excess capacity

14. Transmission mechanism of monetary policy:
The mechanism by which changes in monetary policy affect
aggregate demand is called the transmission mechanism.
This mechanism works by providing a link between rate of
interest and investment and secondly linkiy the investment
with the aggregate demand. Monetary policy through its
transmission mechanism connects the monetary band real
sectors bof the economy.

16. Thank you....😊