- BES171/MP1: Monetary Policy#1: Money Multiplier, Narrow, Broad & High Powered Money
- BES171/MP2: Monetary policy: SLR, CRR, Incremental CRR after Demonetization
- BES171/MP3: Open Market Operations (OMO) Market Stabilization Scheme (MSS) after Demonetization
Prologue: from now on, all Powerpoint available at http://mrunal.org/powerpoint
- So far in the budget and economic survey series 2017 (BES17): we’ve covered the evolution of money with special focus on digital payment in the light of de-monetization.
- Now we shall move to monetary policy- tools, review of last one year’s policies and its limitations.
- But, first we must learn how can a Central Bank control money supply and liquidity in the system?
- In his book the General theory of employment, interest and money, the famous Economist John Maynard Keynes listed the motives for which people demand and keep money in liquid form 1) transaction motive 2) precautionary motive and 3) speculative motive- also known as the asset demand of money.
- We measure the money supply thus kept as “M1”- which is currency with public plus demand deposits in the banks. Because of the fractional reserve system, Every “R” reserve generates “1/r” new money
- What is money multiplier, why is it said that in a functional economy, money multiplier is always greater than one?
- What is M0: reserve money or high powered money? Why is it called liability of RBI?
- Measures of money supply: M0, M1, M2, M3, M4. what is broad money and what is narrow money? Which one has the highest liquidity?
- How can RBI combat inflation and deflation? What type of policy strategy should it use against these two scenarios? What is easy money policy, cheap money policy, dovish money policy vs. tight money policy, dear money policy, Hawkish money policy.
Youtube Link: https://youtu.be/9Limo3CUVgM
- The commercial banks liabilities be classified in three parts 1) time liabilities 2) demand liabilities and 3) other liabilities.
- Out of the net demand and time liabilities (NDTL), commercial banks are required to maintain cash reserve ratio and statutory liquidity ratio (SLR) under the provisions of reserve bank of India act and banking regulation act with a lag of fortnight.
- In the pre-LPG reforms era, high level of CRR and SLR were major impediments against business expansions and exports. But after the BoP crisis of 1991, as per the recommendations of M.Narasimhan Committee on banking sector reforms, both these ratios have been gradually decreased.
- Post-demonetization of Rs. 500 and Rs. 1000 notes in November 2016, there was a surge in the NDTL of commercial banks. Had RBI maintained status quo in CRR and SLR, then this excess NDTL would have translated into very cheap lending rates, thereby destabilising our economy. Hence, RBI introduced the idea of incremental CRR for a short period.
- In incremental CRR system, SCB were required to keep 100% of their NDTL during 16th September to 11th November, as CRR for the fortnight from 26th november to 10th December.
Youtube Link: https://youtu.be/-DsJ-T6AuTM
- Since RBI is the public debt manager, it has to purchase unsold government securities. And later on, using these securities, RBI can conduct open market operations to increase or decrease money supply, and thus, combat against inflation or deflation.
- But, suppose RBI runs out of government securities then how can it absorb liquidity? Such scenario happened in 2003, and subsequently, an MoU was signed between RBI and the government of India, wherein RBI can issues market stabilization scheme (MSS) securities to job excess liquidity from the system, even when government is not interested in borrowing.
- Post-demonetization, the ceiling for MSS-securities was increased from Rs.30,000 crores to Rs. 6 lakh crores, and they were utilized to absorb the excess NDTL after the deadline for incremental CRR had expired.
Youtube Link: https://youtu.be/66ywDYXXQYc
Next lecture: continued with remaining of the quantitative and qualitative tools of money policy.