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PRESENTED BY:

IQRA ASHFAQ
1028
NAYAB AMIN
1007
FILZA WARIS
1017

MEANING
Monetary policy is an instrument which effect
the credit flow in an economy.

DEFINITION
It is a policy of Central Bank to control the supply
of money with aim of achieving of macro
economics stability
(Harry Johnson)

Objective
Full employment
Increase in the production
Increase in the investment
Economic development
Stability of capital market
Proper distribution of wealth
To increase export
Exchange rate stability
Improvement of standard of living

INSTRUMENTS
GENERAL (QUANTITATIVE) Methods

SELECTIVE (QUALITATIVE) Methods

Instruments of Monetary Policy


SLR

Bank rate

Open market
operations

Cash
Reserve
Ratio

QUALITATIVE

QUANTITATIVE

Credit
Rationing

Change in
Lending
margins

Direct
Controls

Moral
Suasion

GENERAL (QUANTITATIVE) Methods


Meaning:-

These methods help in credit control in the


economy.
Affect total quantity of the credit.

Types
A. Bank rate policy

B. Open market policy


C. Cash reserve ratio
D. Statuary reserve ratio

Bank Rate policy


Traditional approach:- Bank rate means on
which central bank discounts and rediscount the
eligible bills.
Todays approach:- Bank rate means the
minimum rate on which central bank provides
financial accommodation to commercial bank in
the discharge of its function as the lender of the
last resort.

Effect of Bank rate


Increase in bank rate

Decrease in bank rate

Increase in bank rate charge


by the central bank on its
advance to commercial bank.
Commercial bank increase the
rate of interest on their loan.
Demand for the credits and
loan decrease.
Flow of the money decrease in
the economy
Use in inflationary situation

Decrease in bank rate charge


by the central bank on its
advance to commercial bank.
Commercial bank decrease the
rate of interest on their loan.
Demand for the credits and
loan increase.
Flow of the money increase in
the economy
Use in depression situation

Open Market operation


Its include the sales and purchase by the central
bank of .
Assets
Foreign exchange
Gold
Government securities
Company securities

Use of Open Market operation


In the inflationary situation

In the depressionary situation

Central bank decrease the


money supply.
Central bank sale out the
securities to commercial bank
and control money supply.

Central bank increase the


money supply.
Central bank purchase the
securities from the commercial
bank.

Cash Reserve Ratio


Commercial bank has to keep a certain
percentage of his deposits with central bank.
It control the cash flow in economy.

It keeps changes in monetary policy framed by


central bank of a country.

STATUARY LIQUIDITY RATIO


Commercial bank is to keep a certain percentage
of his deposit as liquid asset.
It control the cash flow in economy.

It keeps changes in monetary policy framed by


central bank of a country.

Use of C.R.R. & S.L.R


In Inflationary situation

In Depressionary situation

o Increased the percentage of


cash reserve ratio and
Statutory liquidity ratio
o It reduces the supply of money
in an economy

o Decreased the percentage of


cash reserve ratio and
Statutory liquidity ratio
o It increases the supply of
money in an economy

Function of credit regulation the


quantitative methods
For expansion of credit

For contraction of credit

Reduce the bank rate


Purchase of securities
Reduce the C.R.R.
Reduce the S.L.R.

Increase the bank rate


sales of securities
Increase the C.R.R.
Increase the S.L.R.

Specific or qualitative Credit Control

Adopt for expansion and contraction of credit to


attain specific objective.

Methods of qualitative credit control


Fixing Margin Requirements
Publicity
Credit Rationing
Moral Persuasion
Direct Action

Fixing Margin Requirements:


Margin refers to difference between market value
and amount borrowed against the securities. Bank,
while advancing loan against security, do not lend
the full amount, but less.

Publicity:

Through it Central Bank publishes various reports


stating what is good and what is bad in the system.
This published information can help commercial
banks to direct credit supply in the desired sectors.
Through its weekly and monthly bulletins, the
information is made public and banks can use it for
attaining goals of monetary policy.

Credit Rationing:
Central Bank fixes credit amount to be granted.
Credit is rationed by limiting the amount available
for each commercial bank. This method controls
even bill rediscounting.

Moral Persuasion:
This is used by many countries. It has a great
influence over the loan policy of banks. There is a
co-operation between them. Under this, the Central
Bank makes an informal request to Commercial
Bank to contract loans in the time of inflation and
expand loans in depression.

Direct Action:
This includes charging penalty interest rates,
qualitative credit ceiling etc. on Commercial
Bank. It has its direction and restrictive
measures, which all the concern banks should
follow regarding the lending and investment.

AGGREGATE DEMAND AND SUPPLY OF


MONETARY POLICY

Expansionary

monetary policy is monetary


policy that increases aggregate demand.

Contractionary

monetary policy is monetary


policy that reduces aggregate demand.

Expansionary Monetary Policy to Fight a Recessionary Gap

Contractionary Monetary Policy to Fight an Inflationary Gap

THEORIES OF MONETARY POLICY


QUANTITY THEORY OF MONEY:
According to this theory, an increase (decrease)
in the quantity of money leads to a proportional
increase (decrease) in the price level. The
quantity theory of money is usually discussed in
terms of the equation of exchange, which is
given by the expression

MV=PY

KEYNESIAN THEORY:
Developed by John Maynard Keynes and his
students.
Keynesians do believe in an indirect link between
the money supply and real GDP. They believe that
expansionary monetary policy increases the supply
of loan able funds available through the banking
system, causing interest rates to fall. With lower
interest rates, aggregate expenditures on investment
and interest-sensitive consumption goods usually
increase, causing real GDP to rise. Hence, monetary
policy can affect real GDP indirectly.

Stimulative Monetary
Policy
Fed

Treasury
Securities

Investors

Bank Funds
Increase

Interest Rates
Decrease

Aggregate
Spending
Increases

Bank Funds
Decrease

Interest Rates
Increase

Aggregate
Spending
Decreases

Restrictive Monetary
Policy
Fed

Treasury
Securities

Investors

Inflation
Decreases

MONEY MULTIPLIER

Definition of 'Multiplier Effect'


The expansion of a country's money supply that
results from banks being able to lend. The size of the
multiplier effect depends on the percentage
of deposits that banks are required to
hold as reserves. In other words, it is money used to
create more money and is calculated by dividing
total bank deposits by the reserve requirement.

BANKS

NEW
DEPOSITS

RERUIRED
RESERVE
RATIO 20%

LOAN
80%

1,000

200

800

800

160

640

640

128

512

Other banks

2,560

512

2,048

..

TOTAL

5,000

1,000

4,000

Tradeoff of Monetary Policy


Goals
Goals of the Monetary Policy
Steady GDP growth
Low unemployment
Stable price levels

Tradeoffs
Lowering unemployment by stimulating the
economy may increase inflation
Lowering inflation by slowing the economy
may increase unemployment

Economic Indicators
Monitored by the Fed
Indicators of economic growth

Gross Domestic Product or GDP


Industrial production
National income
Unemployment

Indicators of Inflation
Producer price indexes
Consumer price Indexes
Other indicators

Economic Indicators
Monitored by the Fed
How the Fed uses indicators
Fed meets to decide course of monetary policy
Assesses recent reports on indicators of growth
and inflation
Uses indicators to anticipate how the economy
will change
Decides the appropriate monetary policy given
possible conditions