Money Supply and Monetary Policy Final

8/3/2019 Money Supply and Monetary Policy Final

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Money

Functions of money :

Medium of exchange

Unit of accountA standard of deferred payments

A store of Value

To influence the economy of thedynamic function of money


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Money Supply and Monetary Policy

In economics, the money supply or

money stock, is the total amount of

money available in an economy at a

particular point in time


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Aggregate of Money Supply in India

The Reserve Bank of India defines the monetary aggregatesas

Reserve Money (M0): Currency in circulation + Bankersdeposits with the RBI + Other deposits with the RBI

M1: Currency with the public + Deposit money of the public(Demand deposits with the banking system + Otherdeposits with the RBI).

M2: M1 + Savings deposits with Post office savings banks.

M3: M1+ Time deposits with the banking

M4: M3 + All deposits with post office savings banks(excluding National Savings Certificates


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NM1 Currency with the public +

Demand deposits with the

banking system + Other

deposits with the RBI.

NM2 NM1 + Short-term time deposits

of residents (including and up

to the contractual maturity of

one year).

NM3 NM2 + Long-term time deposits

of residents + Call/Term

funding from financial

institutions.


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Liquidity Aggregates

L1 NM3 + All deposits with the

post office savings banks

(excluding National Savings

Certificates).

L2 L1 +Term deposits with term

lending institutions and

refinancing institutions (FIs) +

Term borrowing by FIs +

Certificates of deposit issued by

FIs.

L3 L2 + Public deposits of nonbanking

financial companies


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Determinants of money supply

There are two types of money

M= Ordinary money

H= High powered money or base money

M= C+ DD +OC

H= C + R + OD

The difference between R and DD can be explained

with the concept of credit creation by banks .


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Determinants of Money Supply

Ms= m.H

WhereMs = Money Supply

m=money multiplier

H= High powered money


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Credit creation by commercial banks

Assumption

Currency deposit ratio =c=.5Required reserve ratio = r =0.1

Assets of banks are only loans given by

themBanks offer only demand deposits


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Process

Public comes in possession of H worth Rs 60

crores . Public keep Rs 20 crores in currency

and Rs 40 crores in bank deposits . Banks have

Reseves of Rs 40 crores.As r is .1 banks keep

Rs 4 crores in cash and rest of the money the

lend .


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Deposits Currency Reserves Derivative

deposits

40 20 4 36 Ist round of

credit creation

24 12 2.4 21.6 Second roundcredit creation

14.4 7.2 1.44 12.96

Total = 100 Total =50 Total=10 Total=90 N ROUNDS OF

CREDIT

CREATION


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Various multipliers

Deposit multiplier = 1/(c+r)=1.667

Bank credit multiplier = 1- r/(c+r)=1.5

Money multiplier = 1+c/(c+r) =2.5


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Determinants of money supply

H

C

r


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NUMERICALS


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Answer

Money supply in the economy MS = High powered money x moneymultiplier

Money Multiplier mm =1 +c / c + r

=1 +.20 / .20 + .15

mm =1.20 / .35 =3.4

High powered Money = Credit to govt. + Credit to banks + Credit toCommercial Sector + Foreign Exchange assets +Other Assets Govt.Deposits Net worth Other Non Monetary liabilities

=1650 +520 +140 +25 +15 -80 -350 -10

=1910

High powered Money =1910 +25 (govt. money)

=1935

Money Supply =1935 x 3.4 = 6579

Money Supply = 6579 MUC


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The following balances have been taken from the balance sheet of the Central Bank

of an economyMillion Unit of Currency

Credit to Government 650Credit to Bank 400

Government Deposits 15

Net worth 375

Other None-monetary Liabilities 5

Credit to Commercial Sector 65

Foreign Exchange Assets 20

Other Assets 55

The currency/deposit ratio is 0.35 and the Central Bank imposes a reserve

ratio of 6%. The government money in the economy is negligible and can be

ignored.a. Calculate the money supply in the economy.

b. The country is about receive a foreign aid to the tune of 100

million unit of Currency. What should be the new reserve ratio to

sterilize the effect of the aid on the money supply of the economy?

c. If the Central Bank wishes to sterilize the effect of aid only to the

extent of 50%, what should be the new reserve ratio?


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Answer

A. 2618

B.r= 0.1115 or 11.15%

C. 0.084 or 8.4%


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Monetary policy

The monetary policy of any country refers tothe regulatory policy , whereby the monetaryauthority maintains its control over (i) the

supply of money ii) availability of money, and(iii) cost of money or rate of interest for therealization of general economic goals such asstability of employment, and prices ,

economic growth , and balance ininternational payments .


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Types of monetary policy

Expansionary or Cheap or easy monetary

policy

Contractionary policy ,dear or tight monetarypolicy


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Instruments of

Monetary

policy

Quantitative Tools

Open

Market

Requireme

nts

BankRate

CRR

Secondary

Reserve

Requirements

RepoRate ,Rever

seRepoRates

Qualitative Tools

Rationi

ng ofCredit

Changes

in MarginRequirem

ents

RegulationOf

Consumer

Credit

Moral

Suasion

DirectAction


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Monetary Policy in Developing

Economy

The objective of the Monetary policy is growth

with equity . But the monetary policy is not

effective due to existence of Large organize

sector , time lags in the monetary policy .


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Conclusion

Monetary and fiscal policies are

interdependent . For example if the

government adopts the deficit financing than

RBI can adopt a tight money policy. The

objective of the Monetary policy is growth

with stability . But the monetary policy is not

effective due to existence of Largeunorganized sector , time lags in the monetary

policy .


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Current Rates

Bank Rate : 6 %

Repo Rate :8.5

Reverse Repo Rate :7.5%

CRR: 6% SLR:24%

Base Rate : 10.00-10.75%

Saving BANK Rate : 4%

Deposit Rate 8.5-9.5% Call Rates : 7.0- 9.75%

Marginal Standing Facility Rate : 9.5%


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Monetary Policy in India


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Current ates

Bank Rate : 6 %

Repo Rate :8.5

Reverse Repo Rate :7.5%

CRR: 6% SLR:24%

Base Rate : 10.00-10.75%

Saving BANK Rate : 4%

Deposit Rate 8.5-9.5% Call Rates : 7.0- 9.75%

Marginal Standing Facility Rate : 9.5%

Documents

Money Supply and Monetary Policy Final