02/12/20

• Recap (Business Cycle- Significance, Phases/stages,impact,

examples,reasons/factors,Theories,Policy measures)
Banking and Monetary policy
• Barter to Money -Functions of Money-Demand for Money
• Origin of Banking
• The Phenomenon of Multiple Expansion of Deposits -Creation of Credit
• Money Supply- Equation of Exchange-Quantity theory of Money
• Evolution of Central Banking
• Banking In India – (Colonial era, Post Independence, Post Nationalisation,Post
Economic Reforms – Banking in the new Millennium)
• Role of Central Banking -RBI (Reserve Bank of India)
• Monetary Policy
• When interest rate goes up, the borrowing cost goes up and
hence cost of production goes up .Interest rate is a part of
Monetary policy.
• When Tax rate goes up , the cost of production goes up. Tax
rate is a part of Fiscal Policy.
 Barter to Money

• Barter System
• Disadvantages
• In order to exchange goods, there has to be a double coincidence of
wants
• Requires a rate of exchange to be established between two
commodities to be exchanged
• All commodities are not finely divisible
 Functions of Money
• Medium of exchange ( Measure of value and standard or unit of
account)
• Acceptability
• Kinds of money – From Cattle to Coins to Currency to Paper to Cheque –
Bitcoins?
• Intrinsic value- Face Value
• Paper money- From Commodity to Debt money.
• Money as a store of value.
• Demand for Money
 Origin of Banking –Commercial Banks

• Britian- 17 th Century
• Goldsmiths
• Gold Deposits-Deposit Receipts
• Fractional Reserve system
• Assets and Liabilities
• Demand Deposits – Time Deposits
 Creation of Credit
• BANK A - X 1000
• Y borrows 900
• BANK B – 900
• Z borrows from B 800
• Deposits in Bank C
 The Phenomenon of Multiple Expansion of Deposits -Creation of Credit

• Individuals – X,Y,Z Banks –A, B, C

• Mr. X gets salary of Rs 1000 and deposits in Bank A
• Balance Sheet of Bank A
• Liabilities- Deposit of X +Rs.1000,Assets- Cash +1000
• Let us say Bank A(keeping only 10 percent in Cash) lends 900 to Mr.Y
• Balance Sheet of Bank A
• Liabilities- Deposit of X- Rs.1000+ 900 =+1900
• Assets- Cash 1000 +Loan 900=+ 1900
• Let Mr.Y who has taken loan from A, issue a Cheque for Rs.900 to Mr Zfrom whom
he has bought goods.Let Z deposit this Cheque in his account in bank B.
• Balance Sheet of Bank A
• Liabilities- Deposit of X +1000
• Assets- Cash 1000 +Loan 900= +1900
• Balance Sheet of Bank B
• Liabilities- Deposit of +900
• Assets- Cash +900
• Bank B keeps only 10 percent and lends Rs.810. The borrower of this money
deposits this in Bank C
• Balance Sheet of Bank B -Liabilities- Deposits +810, Assets- Cash + 810
• 1000+900+810+729+……….. Geometric Series 1000/10= 10,000
• Limitations-Cash Leakage
 08/12/20
• Recap
• Revision through applications
• Delhi’s Pollutions( Heavy traffic, Burning by neighbor states Farmers)
Externalities(negative),Tragedy of the Commons.
• Indian Aviation- Indian Airlines(Domestic), Air India(International)
• Low Cost Airlines – Law of Demand,Price elasticity, Income elasticity and Cross-Elasticity of Demand
• Financing systems –Bajaj Finance
• Indian Economic Reforms (Liberalisation,Privataisation and Globalaisation)
• Nokia-Samsung (Android),
• Mergers – Economies of Scale
• Jet,King Fisher,Sahara, Go Air, Indigo-
• Development Economics, Economic Reforms, Economic systems,Competition
• Farm bill debate (MSP, Procurement Price)
• Recent performance of Indian Economy
• Recent performance of Indian Economy
• Economics for Everyone- Pricenomics- Sailing towards
Stagflation (Recession and Inflation)
 09/12/20
Recap
• Money Supply- Equation of Exchange-Quantity theory of Money
• Evolution of Central Banking
• Banking In India – (Colonial era, Post Independence, Post Nationalisation,Post
Economic Reforms – Banking in the new Millennium)
• Role of Central Banking -RBI (Reserve Bank of India)
• Monetary Policy
• Challenges in India
 Money Supply- Equation of Exchange-Quantity theory of Money

• Equation of Exchange MV = PT or MV= PY

• M= Amount of Money V=Velocity of its circulation
• P= Price T= Total goods (Services) traded
• Y= Transactions related to real output.
• Quantity Theory of Money
 Evolution of Central Banking

• Functions of a Central Bank

• Power to issue notes
• To act as a Bankers Bank
• To act as a Banker to the Government
• To act as a lender of last resort
• Control of Credit
• Recap
• Indian Banking System
• Banking In India (Colonial era, Post Independence, Post
Nationalisation,Post Economic Reforms – Banking in the new
Millennium)
• Role of RBI
• Monetary Policy
Indian Banking System
 Banking In India
• Colonial era
• Post Independence
• Post Nationalisation
• Post Economic Reforms
• Banking in the new Millennium- Retail Banking,Technology in
Bank
Role of Central Banking -RBI (Reserve Bank of India)
• The regulation of the money supply and interest rates by a central bank, such as
the Reserve Bank of India, is in order to control inflation and stabilize currency.
Monetary policy is one the ways the government can impact the economy.
• By impacting the effective cost of money, the Reserve bank can affect the
amount of money that is spent by consumers and businesses. It regulates the
supply of money and the cost and availability of credit in the economy. It deals
with both the lending and borrowing rates of interest for commercial banks. The
Monetary Policy aims to maintain price stability, full employment and economic
growth. The Reserve Bank of India is responsible for formulating and
implementing Monetary Policy. It can increase or decrease the supply of
currency as well as interest rate, carry out open market operations, control credit
and vary the reserve requirements.
 ROLE OF RESERVE BANK OF INDIA
• ROLE OF RESERVE BANK OF INDIA:
• Establishment
• The Reserve Bank of India was established on April 1, 1935 in accordance with the
provisions of the Reserve Bank of India Act, 1934.
• The Central Office of the Reserve Bank was initially established in Calcutta but was
permanently moved to Mumbai in 1937. The Central Office is where the Governor
sits and where policies are formulated.
• Though originally privately owned, since nationalisation in 1949, the Reserve Bank
is fully owned by the Government of India.
• Preamble
• The Preamble of the Reserve Bank of India describes the basic
functions of the Reserve Bank as:
• "...to regulate the issue of Bank Notes and keeping of reserves
with a view to securing monetary stability in India and
generally to operate the currency and credit system of the
country to its advantage."
• Monetary policy is the process by which a central bank (Reserve Bank of
India or RBI) manages money supply in the economy.
• The objectives of monetary policy include ensuring inflation targeting
and price stability, full employment and stable economic growth.
• The money supply can be directly affected through reserve
ratios or open market operations and can be indirectly affected
by using key interest rates to influence the cost of credit.
• An easy or expansionary monetary policy is implemented by
reducing statutory bank reserves or lowering key interest rates
and improving market liquidity to encourage economic activity.
• A contractionary or tight monetary policy reduces liquidity and
increases interest rates which has a negative impact on both
production and consumption and therefore, economic growth.
 RBI
• Main Functions
• Monetary Authority:
• Formulates, implements and monitors the monetary policy.
• Objective: maintaining price stability and ensuring adequate flow of credit
to productive sectors.
• Regulator and supervisor of the financial system
• Prescribes broad parameters of banking operations within which the
country's banking and financial system functions.
• Objective: maintain public confidence in the system, protect depositors'
interest and provide cost-effective banking services to the public
• Manager of Foreign Exchange
• Manages the Foreign Exchange Management Act, 1999.
• Objective: to facilitate external trade and payment and promote orderly
development and maintenance of foreign exchange market in India.
• Issuer of currency:
• Issues and exchanges or destroys currency and coins not fit for
circulation.
• Objective: to give the public adequate quantity of supplies of currency
notes and coins and in good quality.
Developmental role
Performs a wide range of promotional functions to
support national objectives.
Related Functions
Banker to the Government: performs merchant banking
function for the central and the state governments; also
acts as their banker.
Banker to banks: maintains banking accounts of all
scheduled banks.
The above objectives are carried out through the
following channels or ways of monetary management
CHANNELS OF MANAGEMENT:
There are four main ‘channels’, which the RBI
looks at:
Quantum channel: money supply and credit
(affects real output and price level through
changes in reserves money, money supply and
credit aggregates).
Interest rate channel.
Exchange rate channel (linked to the currency).
The above policy instruments in turn impact
the “Asset price” in the economy
• In the following discussions we will discuss what are the different
instruments under quantum channel and interest rate channel
used by the RBI for monetary management. They form the key
components of the monetary policy
INFLATION, INTEREST RATES AND THE RBI
Interest rates measure the price of borrowing money. If a business wants to borrow
Rs 1 million from a bank, the bank will charge a specific interest rate that will usually
be expressed in terms of a percentage over a given period of time. For example, if
the bank loaned the money to the company at a 5% annual rate, the company
would need to repay Rs 1,050,000 at the end of the year. From the company's
perspective, the value of that Rs 1,000,000 right now is greater than the Rs
1,050,000 in a year (presumably because they have plans for the money), which is
why they want to borrow it. For the bank, it is earning a 5% return on a one-year
investment. Generally, there are two types of interest rates: floating and fixed
• RELEVANCE OF MONETARY AND CREDIT POLICY
• Historically, the Monetary Policy is announced twice a year - a slack season policy (April-
September) and a busy season policy (October-March) in accordance with agricultural
cycles. These cycles also coincide with the halves of the financial year. However, with the
share of credit to agriculture coming down and credit towards the industry being
granted whole year around, the RBI since 1998-99 has moved in for just one policy in
April-end. However a review of the policy does take place later in the year.
• The monetary and credit policy is half yearly affair of the Reserve Bank of Traditionally,
RBI, in this monetary and credit policy, announces structural and monetary measures to
improve the functioning of the banking system and also functioning of the economy as
whole. There are some key set of indicators to ensure stability in the economy. These
include money supply, interest rates, inflation, amongst others. The RBI uses various
tools to regulate or influence these indicators. The policy also provides a platform for
the RBI to announce norms for financial entities including banks, financial institutions
(FIs), non-banking financial companies (NFBCs), nidhis, primary dealers (PDs) in the
money market, authorized dealers in the foreign exchange markets, which are regulated
by the apex bank
• IMPACT ON THE INDIVIDUAL:
• In recent years, the policy had gained in importance due to announcements in
the interest rates. A reduction in interest rates would force banks to lower their
lending rates and borrowing rates. So if you want to place a deposit with a bank
or take a loan, it would offer it at a lower rate of interest. On the other hand, if
there were to be an increase in interest rates, banks would immediately
increase their lending and borrowing rates. Since the rates of interest affect the
borrowing costs of corporates and as a result, their bottomlines (profits), the
monetary policy is very important to them also. Earlier, depending on the rates
announced by the RBI, the interest costs of banks would immediately either
increase or decrease. . Since the financial sector reforms commenced, the RBI
has moved towards a market-determined interest rate scenario. This means
that banks are free to decide on interest rates on term deposits and loans.
Being the central bank, however, the RBI would have a say and determine
direction on interest rates, as it is an important tool to control inflation. The
bank rate is a tool used by RBI for this purpose as it refinances banks at this
rate. In other words, the bank rate is the rate at which banks borrow from the
RBI.
• RBI’S CONDUCT OF MONETARY POLICY:
• The RBI uses the interest rate, OMO, changes in banks' CRR and primary
placements of government debt to control the money supply. OMO,
primary placements and changes in the CRR are the most popular
instruments used.
• OPEN MARKET OPERATIONS (OMO)
• Under the OMO, the RBI buys or sells government bonds in the
secondary market. By absorbing bonds, it drives up bond yields and
injects money into the market. When it sells bonds, it does so to suck
money out of the system.
• Primary deals in government bonds are a method to intervene directly
in markets, followed by the RBI. By directly buying new bonds from the
government at lower than market rates, the RBI tries to limit the rise in
interest rates that higher government borrowings would lead to
CRR Cash Reserve Ratio
• All commercial banks are required to keep a certain amount of its
deposits in cash with RBI. This percentage is called the cash reserve
ratio. The changes in CRR affect the amount of free cash that banks can
use to lend - reducing the amount of money for lending cuts into overall
liquidity, driving interest rates up, lowering inflation and sucking money
out of markets. The CRR is the proportion of their deposits, which banks
have to keep with the RBI. Raising the CRR is one of the most effective
ways for the RBI to suck liquidity out of the financial system, which
reduces demand in the economy and therefore helps curb inflation.
Bank Rate
• Bank rate is the minimum rate at which the central bank
provides loans to the commercial banks. It is also called the
discount rate.
• Usually, an increase in bank rate results in commercial banks
increasing their lending rates. Changes in bank rate affect
credit creation by banks through altering the cost of credit.
• Prime lending rate: The rate at which banks lend to their best
customers
Money Supply
• The RBI has adopted four concepts of measuring money supply.
The first one is M1, which equals the sum of currency with the
public, demand deposits with the public and other deposits with
the public. Simply put M1 includes all coins and notes in
circulation, and personal current accounts.
• The second, M2, is a measure of money, supply, including M1,
plus personal deposit accounts - plus government deposits and
deposits in currencies other than rupee.
• The third concept M3 or the broad money concept, as it is also
known, is quite popular. M3 includes net time deposits (fixed
deposits), savings deposits with post office saving banks and all
the components of M1.
• Statutory Liquidity Ratio
• Banks in India are required to maintain part of their (around 25 per
cent) of their demand and time liabilities in government securities
and certain approved securities.
• LAF (THE LIQUIDITY ADJUSTMENT FACILITY)
• The LAF can be thought of as a way for the RBI to lend and borrow
to banks for very short periods, typically just a day. The repo rate is
the RBI's lending rate and reverse repo rate is the RBI's borrowing
rate. These two rates help the RBI influence short-term interest
rates in the rest of the financial system
• Repo (Repurchase) Rate:
• The rate at which the RBI lends money to commercial banks is called repo rate. It is an
instrument of monetary policy. Whenever banks have any shortage of funds they can
borrow from the RBI. An increase in the repo rate means banks get money at a higher
rate than earlier and vice versa. The repo rate in India is similar to the discount rate in
the US.
• Reverse Repo rate:
• Reverse Repo rate is the rate at which the RBI borrows money from commercial banks.
Banks are always happy to lend money to the RBI since their money is in safe hands
with a good interest. An increase in reverse repo rate can prompt banks to park more
funds with the RBI to earn higher returns on idle cash. It is also a tool which can be
used by the RBI to drain excess money out of the banking system
• The current rates as per RBI Monetary Policy are: SLR is 21.50%, Repo rate is 4.00%,
Reverse Repo rate is 3.35%, MSF rate is 4.65%, CRR is 3% and Bank rate is 4.65%.
• 'Marginal Standing Facility'
• Banks borrow from the central bank by pledging government securities at a rate
higher than the repo rate under liquidity adjustment facility or LAF in short. The MSF
rate is pegged 100 basis points or a percentage point above the rep
• Marginal standing facility (MSF), under which banks could borrow funds from RBI
overnight, which is 1% above the liquidity adjustment facility-repo rate against
pledging government securities. ... LAF is used to aid banks in adjusting the day to
day mismatches in liquidity. LAF consists of repo and reverse repo operations.o rate.
• Relationship between Monetary Policy and Inflation.
• In general it is perceived that prices rise when more money chases few goods. Thus one
of the key tasks in controlling the inflation rate is to control the excessive money supply
in the economy.
• The measured inflation rate at any point in time will be made up of an array of individual
price changes. But the amount of inflation in the economy is about more than just the
sum of all individual price changes. Something more fundamental determines the
amount of inflation in the economy - whether it is 1%, 10% or 100%.
• Inflation is usually generated by an excess of demand over supply. To contain inflationary
pressures in the economy, demand needs to grow roughly in line with output. Output
grows over time at a rate which largely depends on factors which increase productivity.
If demand grows faster than this, unless there is spare capacity in the economy - such as
after a recession - inflation is likely to rise.
 Issue of CRR
• For banks, CRR hurts: they earn nothing off it, turning the item on their balance sheets into,
effectively, a non-performing asset (NPA).
• - Another view is that liquidity can be managed through the central banks’ open market
operations, and the liquidity management process through CRR can be done away with.
• - Some experts question whether CRR serves really the purpose. According to them if the
purpose of CRR is to prevent banks from becoming insolvent that can be done by SLR. The
SLR requirement in inida is around 23%, which banks can't give as collateral to raise any
loan. According to some experts, at present around Rs 17.4 lakh crore is locked up in these
two provisions (CRR,SLR) in the banking system as a whole. So critics question whether so
much required in a system where 75% of the banking industry is still owned by the state.
According to the experts, lowering of these reserve requirements theoretically would
release that much funds for private entrepreneurship, bringing down the cost of funds in
general.
• Continuance of CRR, more so without any interest payout, has lost all
purpose. Much of a bank’s manpower and top management time is
spent maintaining CRR on a daily basis, and this is avoidable. Banks are
customers to RBI, as far as maintenance of cash balances with the
central bank is concerned. Their demand from the RBI is akin to a bank
demanding cash margin from a borrower, and paying interest on the
cash margin.
 Revision
Foundations/Basics
• Why Economics-What Economics- Need for Economic Literacy- Goods & Services,Need and Want,
Demand and Supply,Equilibrium,Oppourtunity Cost, Sunk Costs,Marginal Costs, Public Goods,
Economic Goods and Free Goods, Externalities(Positive,Negative), Stock and flow, Positive vs
Normative,Economic activity,Circular flow (various participants),Theories of factors of Production,
Micro and Macro Economics,Barter System.
• Schools of Economics(Mercantalism,Phisiocrats,Classical, Neo-Classical, Monetarist, Keynes,Karl
Marx- Adam Smith, David Ricardo, Alfred Marshal, JB.Say, JM Keynes Karl Marx,Milton Friedman)
• Economic Systems – Capitalism, Socialism, Mixed Economy
• Great Depression,Financial Crisis, Chinese Revoution,Russia
• Demand determinants- Law of Damand,Charactersitics,Exceptions, Price Elasticity of Demand,
Applciations, Cross Elasticity of demand
• Cost and Productions functions – Various cost concepts, Cost –Output relationship in the short run
and Long run ( AC,MC,FC), Production Funnction, Law of variable proportions /diminishing
marginal utility, Economies of Scale
• National Income measurements( Concept, Measurements,
Components, Limitations)
• Unemployment and Poverty ( Concept,Measurements)
• Development Economics concepts – HDI,HDR,SOC,DPA, MDG
• Inflation( Concept,Causes,Measurement… WPI,CPI)
• Business Cycle ( Phases)
• Monetary Policy ( Money and Banking