Repo Rate Effect on Monetary Policy

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PROJECT SUBMISSION FOR MACROECONOMICS

TOPIC

EFFECTS OF MONETARY POLICY ON GDP

SUBMITTED TO:

PROF. CHANDAN SHARMA

SUBMITTED BY:

GOWTHAM DHANAPAL (PGPSM03010)

NIKITA WANKHEDE (PGPSM03018)

S. DEVANAND(PGPSM03026)

Table of Contents

INTRODUCTION        3

BACKGROUND        4

METHODOLOGY        5

Assumptions        5

ANALYSIS        5

Graphs        5

Monetary Policy 1990-93        6

Monetary policy 2007-2010        7

FINDINGS FROM THE STUDY        9

REFERENCE        11

INTRODUCTION

The macroeconomic policy which involves control of money supply with an overarching goal of ensuring price stability and general trust in the currency is called Monetary policy. It’s laid down by the monetary authority of the nation, generally the central bank and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.

In India, monetary policy of the Reserve Bank of India is aimed at managing the quantity of money in order to meet the requirements of different sectors of the economy and to increase the pace of economic growth or stabilizing it from falling into a potential crisis.

The core objectives of RBI are Price Stability or Control of Inflation, Economic Growth, and Exchange Rate Stability within the framework of the general economic policy

Some instruments of the monetary policy are:

• Repo rate
  Repo rate is the rate at which RBI lends to its clients generally against government securities.
• Reverse repo rate
  Reverse Repo rate is the short term borrowing rate at which RBI borrows money from banks
• Cash reserve ratio (CRR)
  CRR (Cash Reserve Ratio) is the share of bank's total deposit that it needs to maintain (or keep) with RBI in form of cash
• Open market operations(OMO)
  Open market operations (OMO) refer to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system
• Statutory liquidity ratio(SLR)
  Statutory liquidity ratio (SLR) is the Indian government term for reserve requirement that the commercial banks in India require to maintain in the form of cash, gold, government approved securities before providing credit to the customers
• Bank rate
  Bank rate is the rate of interest which a central bank charges on the loans and advances that it extends to commercial banks and other financial intermediaries
• Credit ceiling 
  It’s the maximum cap on the amount a lender can allow somebody to borrow. RBI uses credit ceiling to control over the credit that the commercial banks grant.
• Credit authorization scheme
  The Credit Authorization Scheme (CAS) for bank advances was introduced by the Reserve Bank of India in 1965. Under the Scheme, all scheduled commercial banks have to obtain prior authorization of the Reserve Bank before granting any fresh credit limit of Rs. 1 crore or more to any single borrower
• Moral suasion
  Moral suasion is the act of persuading a person or group to act in a certain way through rhetorical appeals, persuasion or implicit threats, as opposed to the use of outright coercion or force; it is commonly used in reference to central banks, more specifically, attempts by central banks to influence the rate of inflation without resorting to open market operations 
  

BACKGROUND

GDP is the total market value of all final goods and services produced within a given period within a country. The GDP(Y) growth rate is driven by four components which are personal consumption(C), investments(I), government spending(G) and net of export and imports(NX).

Y=C+I+G+NX

The GDP growth rate is important indicator of economic health of the country. If GDP growth rate is positive implies the economy is expanding (expansionary policy effect) and so will other factors like business, jobs and personal income. Similarly, if GDP growth rate is slowing down (contractionary policy effect), then businesses will hold off investments and hiring of new employees.

Furthermore, it is necessary to express the goals of monetary policy and what a monetary policy is affecting. The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values.

In lieu of this, we would like to study how the monetary policy affects the GDP. We would like to study what are the determinants of money supply and their trend as well as result of it in Indian economy by deeply analyzing the tools of monetary policy, which are used in RBI and their effect on overall economic situation.

The above mentioned would be achieved by analyzing the changes in the repo rate and money supply over the span of decade (1990s and 2008-10). The significance of period 1990s is that it was the time when Indian economy opened up while the time period 2007-10 was one of global economic crisis.