MACRO ECONOMICS

MONETARY & FISCAL POLICY

INSTRUMENTS
MONETARY POLICY
INSTRUMENTS
MONETARY POLICY
 Monetary policy refers to the credit control measures adopted
by the central bank of the country.

 The RBI is the main body that controls the monetary policy in
India. Various instruments of monetary policy helps the RBI
control the inflation and liquidity in the economy.

The important objectives of monetary policy are :

 Price Stability
 Full Employment
 Balance Of Payment Equilibrium
 Reduction in the Inequalities of Income and Wealth
 Economic Growth.
 MONETARY POLICY
INSTRUMENTS

QUANTITATIVE CREDIT QUALITATIVE/SELECTIVE

CONTROL CREDIT CONTROL
QUANTITAVE INSTRUMENTS
Quantitative credit control measures are adopted by the
central bank to control the quantity of money.

 Bank rate
 Open Market Operations
 Cash Reserve Ratio
 Statutory Liquidity Ratio
 Marginal standing facility
 Liquidity adjustment facility
 BANK RATE: (6%)
 A bank rate is essentially the rate of interest at which the RBI
lends money to commercial banks without any security or
collateral
 One of the most effective instruments of monetary policy, also
known as Discount Rate Or Base Rate.

 It is also the standard rate at which the RBI will buy or

discount bills of exchange and other such commercial
instruments.

 So now if the RBI were to increase the bank rate, the

commercial banks would also have to increase their lending
rates. And this will help control the supply of money in the
market. And the reverse will obviously increase the supply of
money in the market.
OPEN MARKET OPERATIONS (OMO)
 Open Market Operations involve the purchase and sale of
government securities.

 These operations influence the excess reserves at the disposal

of commercial banks used for credit creation.

 The purchase of securities by a central bank leads to an increase

in the reserves of commercial banks. An increase in the bank
reserves leads to expansion of credit. The central bank
purchases securities during deflation.

 The sale of securities by the RBI leads to decrease in the bank

reserves resulting in the contraction of bank credit. The central
bank sells securities during inflation.
CASH RESERVE RATIO: (4%)
 Cash Reserve Ratio (CRR) is the portion of deposits with the
commercial banks that it has to deposit to the RBI.

 CRR is the percent of deposits the commercial banks have to

keep with the RBI. The RBI will adjust the said percentage to
control the supply of money available with the bank.

 Accordingly, the loans given by the bank will either become

cheaper or more expensive. The CRR is a great tool to control
inflation.
STATUTORY LIQUIDITY RATIO: (18.75%)
 Statutory liquidity ratio is the reserve requirement that the
commercial banks in India are required to maintain in the
form of cash, gold reserves, RBI approved securities, before
providing credit to the customers.

 So increasing the SLR will mean the banks have fewer funds
to give as loans, thus controlling the supply of money in the
economy. And vice versa.
 MARGINAL STANDING FACILITY (MSF): (6%)
 Marginal Standing Facility is an overnight liquidity support provided by
RBI to commercial banks with a higher interest rate over the repo rate.

 MSF can be used by a bank after it exhausts its eligible security

holdings for borrowing under other options like the LAF repo. This
provides a safety valve against unanticipated liquidity shocks to the
banking system.

 Usually, when banks need short term loans from the RBI, they pledge
their security holdings that is above the SLR holdings with the RBI to
get one day loans under repo.
 Under MSF, a bank can borrow one-day loans form the RBI, even if it
doesn’t have any eligible securities excess of its SLR requirement
(maintains only the SLR).
 Significance (out of the implication of clauses) of MSF is that
it can be availed even if the bank doesn’t have the required
eligible securities above the SLR limit. The working of MSF is
thus is indirectly related with SLR.

 According to the RBI, “In the event, the banks’ SLR holdings
fall below the statutory requirement up to one per cent of
their NDTL(Net Demand and Time Liabilities) , banks will not
have the obligation to seek a specific waiver for default in SLR
compliance arising out of use of this facility”.

 The implication is that if a bank has at least 18% of deposits in

the form of SLR eligible securities, (when the SLR is 19%), the
bank can get loans under MSF or there will not be any
disciplinary action.
LIQUIDITY ADJUSTMENT
FACILITY:
An indirect instrument
for monetary control
which controls the flow LIQUIDITY
of money through repo ADJUSTMENT
rates and reverse repo FACILITY
rates.

REVERSE REPO
REPO RATE RATE
REPO RATE: (5.75%)
 Repos are transactions whereby funds are mobilized by selling
securities and simultaneously agreeing to buy them back or
repurchase them at a specified price and date.

 Commercial banks are the sellers and RBI is the buyer of Repo.

 Repo rate is the rate at which the commercial banks borrow

from RBI.

 RBI is conducting repo transactions to infuse liquidity into the

banking system.
REVERSE REPO RATE : (5.50%)
 Reverse repo is an agreement whereby commercial banks first
buy the securities from the RBI and then sell them at a
specified price and date to the RBI.

 Reverse repo rate is the rate at which RBI borrows or absorbs

excess funds from banks.

 RBI is actually borrowing money from the commercial banks

by selling securities.

 RBI is conducting the reverse repo transactions to remove the

excess liquidity from the markets.
SELECTIVE CREDIT CONTROL
Selective methods of credit control are meant to regulate and
control the supply of credit for specific purposes. The
distribution of credit is influenced and not the total volume of
credit.

1. Regulation of margin requirement

2. Regulation of consumer credit
3. Rationing of credit
4. Moral suasion
5. Direct action
REGULATION OF CONSUMER CREDIT
 The central bank regulates the use of bank credit by
customers In order to buy durable consumer goods.

 To control an inflationary situation the central bank

raises the minimum down payments and reduces the
number of installments.

 To avoid depression the central bank will lower the

minimum down payments and increase the number of
installments.
REGULATION OF MARGIN REQUIREMENT
 By raising the margin requirements, the flow of credit to
speculative activities can be reduced by the central
bank.

 If a particular section is in recession, the central bank

encourages borrowing by lowering the margin
requirement.
RATIONING OF CREDIT
 Imposing a ceiling on the availability of credit for specific
purposes or certain sectors is known as credit rationing.
It is adopted during inflation.

MORAL SUASION
 It is the method of persuasion, request and of advice to
the commercial banks by the central bank to regulate
volume of trade.
DIRECT ACTION

 Direct action will be taken against the banks that are

reluctant to implement the policy decisions of the
central bank.

 Refusal of rediscounting facilities, imposing a penal rate

of interest etc are the measures adopted by RBI.
FISCAL POLICY
INSTRUMENTS
FISCAL POLICY
 Fiscal policy is the use of government spending and taxation to
influence the economy. It is mainly concerned with the
revenues and expenditures of the government.

 Government influence the economy by changing the level and

types of taxes, the extent and composition of spending, and the
degree and form of borrowing.

 Fiscal policy is said to be tight or contractionary when revenue

is higher than spending (i.e., the government budget is in
surplus) and loose or expansionary when spending is higher
than revenue (i.e., the budget is in deficit).
THE TOOLS OR INSTRUMENTS OF FISCAL POLICY ARE:

TAXATION:
 The government levies tax on private earnings to provide
various services to the citizens.

 The government levies taxes like income tax, corporation tax,

customs duties, wealth tax, property tax etc.

 Taxes determine the size of disposable income in the hands of

people.

 A change in the tax structure will influence the level of

aggregate demand and employment.
PUBLIC EXPENDITURE (GOVERNMENT SPENDING):

 Public expenditure can be used to stimulate production, income

and employment. Government expenditure forms a highly
significant part of the total expenditure in the economy.

 A reduction or expansion in it causes significant variations in the

total income. It can be instrumental in adjusting consumption
and investment to achieve full employment.

 The important forms of government expenditure s are

expenditures on public works, relief expenditures, subsidies,
transfer payments and social security benefits.
DEBT MANAGEMENT
 When the government spends more than it collects in taxes, it
has to borrow money in order to finance its deficits.

 Government borrowing can be in the form of borrowing from

non-bank financial intermediaries, borrowing from commercial
banking system, drawings from the central bank or printing of
new money.

 The government borrows fund for various activities. Public debt

management includes functions like floating of government
loans, payment of interest and redemption of debts.
SAVINGS
 Savings determine the level of private spending in the
economy. The government adopts compulsory saving
schemes to counteract inflation.
REFERENCE
 https://rbi.org.in

 https://www.imf.org/external/pubs/ft/fandd/2009/
06/pdf/basics.pdf

 “Macroeconomic Theory”, M L Jhingan, 11th Edition.