Emphasize the different money supply metrics that the RBI of India uses.
Credit Control means the regulation of the creation and contraction of credit in the economy. It is an important function of the central bank of any country. In India, the Reserve Bank of India (RBI) controls credit in the economy using various quantitative and qualitative measures. Quantitative meaRead more
Credit Control means the regulation of the creation and contraction of credit in the economy. It is an important function of the central bank of any country. In India, the Reserve Bank of India (RBI) controls credit in the economy using various quantitative and qualitative measures.
Quantitative measures: These are deployed to regulate the volume of credit created by the banking system.
- Bank rate Policy: It is the rate at which the RBI is ready to grant loans to commercial banks or rediscount the approved bills held by commercial banks. An increase in bank rate leads to an increase in other rates of interest and vice-e-versa. Thereby, changing the bank rate affects the cost and availability of credit.
- Open market operations: It refers to the sale and purchase of securities by the RBI to the commercial banks. Sale/Purchase of securities by commercial banks from the RBI results in the increasing/decreasing of cash reserves with the banks.
- Reserve Requirements: The RBI is empowered to change the reserve requirements of the commercial banks. Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are two types of reserve ratio employed by RBI. A higher reserve requirement leaves less credit for banks to lend out.
Qualitative measures: These are deployed to regulate the flow of credit in specific uses
- Marginal requirements: It is the difference between the market value of the security and its maximum loan value. The RBI can increase or decrease the marginal requirement to affect the credit flow.
- Consumer Credit Regulation: The RBI can control the consumer credit by changing the amount that can be borrowed for the purchase of the consumer durables or by changing the maximum period over which the installments can be extended.
- Rationing of credit: In this, the RBI seeks to limit the maximum amount of loans and advances and, also in certain cases, fix ceilings for specific categories of loans and advances.
- Moral Suasion: Here, the RBI tries to morally persuade the banks to cooperate in implementing its policies.
- Direct Action: This step is taken by the RBI against banks that don’t fulfil conditions and requirements. It may involve refusal to rediscount their papers, charging a penal rate of interest over and above the Bank rate etc. It must be noted the effectiveness of credit control measures in an economy depends upon a number of factors and one or more of these measures are adopted by RBI based on the situation.
The total stock of money in circulation among the public at a particular point of time is called money supply. It consists of currency, printed notes, money in the deposit accounts and in the form of other liquid assets. It does not include other forms of wealth such as long-term investments or physRead more
The total stock of money in circulation among the public at a particular point of time is called money supply. It consists of currency, printed notes, money in the deposit accounts and in the form of other liquid assets. It does not include other forms of wealth such as long-term investments or physical assets that must be sold to convert to cash. It also does not include various forms of credit, such as loans, mortgages, and credit cards. The amount of money supply in the economy is crucial as it affects the production, price level, and employment in the economy. The central bank of the country (RBI) publishes following measures of money supply:
Reserve Money (M0): It is the base level for the money supply or the high-powered component of the money supply. It constitutes currency in circulation, Bankers’ deposits with the RBI and ‘other’ deposits with the RBI.
Narrow Money: It typically covers the most liquid form of money that can be easily converted into currency or used for cashless payments for transaction and commerce purposes. RBI publishes M1 and M2 as the two measures of narrow money:
M1: It consists of currency (notes plus coins) held by public and net Demand deposits held with the commercial banks and ‘other’ deposits with the RBI. This is the most liquid and easiest money available for transactions.
M2: It consists of M1 plus Savings deposits with the Post Office Saving banks.
Broad Money: It is a broad classification of money that includes time deposits along with currency in circulation and demand deposits with banks and post offices. They are less liquid than the narrow money. RBI publishes:
M3: It consists of M1 plus net time deposits of commercial banks. It captures the complete balance sheet of the banking sector and is known as aggregate monetary resources. It is the most common measure used for money supply.
M4: M3 plus all deposits with the post office saving banks (excluding National Savings Certificates). Since total deposits with post offices are negligible, there is not much difference between M3 and M4.
In terms of liquidity, these can be arranged as- M1>M2>M3>M4. ‘Other’ deposits with RBI comprise mainly: (i) deposits of quasi-government and other financial institutions including primary dealers, (ii) balances in the accounts of foreign Central banks and Governments, (iii) accounts of international agencies such as the International Monetary Fund, etc. Valuation and analysis of the money supply in the economy helps the policy makers to frame or to alter the monetary policy.
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