Showing posts with label Unconventional Monetary Policy. Show all posts
Showing posts with label Unconventional Monetary Policy. Show all posts

Saturday, November 9, 2024

UNCONVENTIONAL MONETARY POLICY IN INDIA AND WORLD WIDE



What is Unconventional Monetary Policy:

According to RBI’s Deepak Mohanty, “When central banks look beyond their traditional instrument of policy interest rate, monetary policy takes an unconventional character.”

Sub-prime mortgage crisis:

The term is associated with sub-prime lending. Many US banks had lent money to sub-prime borrowers (those borrowers who were rated below the prime borrowers), and these sub-prime borrowers failed to pay back the loans they had taken during real estate boom time. When the bubble burst, banks lost most of their money. Big names Lehman Brothers collapsed and closed their operations, US went into a period of recession and it have an impact on the whole world. US Federal intervened and it tried everything it could do to prevent further collapse through Quantitative Easing.


Liquidity Trap :

Interest rates are very  low / zero and saving rates are very high .

                               but

Public did not invest or spend the money (liquidity is trapped with people)

                            because of

the fear of adverse events like deflation, war.

                                    

Monetary policy in the form of increase of money supply remains ineffective.


Situation in UK during 2009-14 was an example of Liquidity Trap in which Base interest rates were cut to 0.5% in March 2009. 


Quantitative Easing (QE):

Background of QE:

In US, sub prime crisis

             

Financial crisis of 2008

             

situation of Liquidity Trap

             

Zero Bound Rate ( a situation of interest rate being already very low). Federal Reserve is not able to stimulate economic growth by reducing the interest rate further.

             ↓

Quantitative Easing


QE is Expansionary monetary policy involving Open Market Operation (OMO) to deal with the negative impacts of Sub prime crisis and to stimulate the economy , bringing it back to the normal. In QE,FED purchased large quantities of Long term bonds from the market issued by government and private parties.It injected a large amount of liquidity in the economy prior to its scheduled time .It also increased the demand of Bonds ,raising their cost and further bringing down the interest rates in the Economy.


***************It is to be noted that the reduction in the rates in QE is not because of changes in REPO rates but because of Long term bonds .




Federal Tapering:

At the tail end of QE, FED gradually reduced monthly purchase of long term bonds. The process of gradual reduction in purchase of bonds is referred to as Federal tapering .Tapering resulting in less free money with banks and loans becoming costlier, inflation to go high.


IMPACT OF QE ON EMERGING MARKET ECONOMIES (EME):

Returns in emerging economies were higher so investors borrowed money in USA and invested it in markets of EME's .This process of moving capital from USA to EME 's is said to be CAPITAL FLIGHT. Capital flight made QE ineffective in USA to an extent and made inflows in EME'S.


Negative Rate Policy:

In case of this policy, banks charge you interest to keep cash with them, rather than paying you interest. The objective of this policy is to demotivate individual to park money with banks and to motivate him to invest in the market .

Negative interest rates regime might be seen during deflationary periods when people or institutions are inclined to hoard money rather than spend or lend it. Many European countries and Japan adopted this strategy during 2008 depression.


UNCONVENTIONAL MONETARY  POICY IN INDIA:

Helicopter Money:

Money transfer from the central bank to the consumers without any liability of being paid back to the government .The concept is based upon the fact that this money when handed directly to consumers, motivates them to spend it immediately, boosting confidence in the economy. Telangana chief minister KC Rao advocated for this policy with the argument that helicopter money can help states comes out of this economic downturn because of Covid-19.


Incremental CRR(I-CRR): Huge liquidity during the demonetization 2016 /demonetization of 2000 Rs in 2023  led to financial instability and unique situation in the economy. I-CRR is an extraordinary tool to in which CRR is increased and the objective is to manage high liquidity in the economy.


LONG TERM  REPO OPERATIONS (LTRO):

LTRO was adopted by RBI during covid-19.It is an unconventional measure in which RBI has given out loans for the period of 1-3 years at REPO rates. The objective is taken to inject extra liquidity into the banking system and boost credit growth. In the LTRO system, RBI believes that offering banks durable longer-term liquidity at the repo rate can help them lower the rates they charge on retail and industrial loans, while maintaining their margins.


Targeted Long Term Repo Operations (TLRTO): TLTRO is LTRO with certain modifications , the banks will have to invest the amount acquired as a loan under LTRO in specified securities like investment-grade corporate bonds, Commercial Papers, Non-Bank Financial Corporations (NBFCs) and Microfinance Institutions (MFIs).


Operation Twist’: 

Operation Twist provides long term liquidity in the economy for investment purposes by inducing downward pressure on longer-term interest rates by lowering long-term Treasury yields. 


RBI -------------------sale short-term securities-------------- funds available with RBI ---------------- buy long-term government debt papers------------Cheaper funds for long term.


Implications of Operation Twist:

  • short loans costlier and hence controlling inflation in the short run.
  • Lower longer-term yields help boost the economy by making loans less expensive for those looking to buy homes, purchase cars, and finance projects, while saving becomes less desirable because it doesn't pay as much interest.


Friday, November 8, 2024

Monetary Policy: Framework, Goals, Expansionary & Contractionary, MONETARY POLICY COMMITTEE, Flexible Inflation Targeting,




Monetary policy: 

Monetary policy consists of the actions of a central bank, or any regulatory committee (Monetary Policy Committee) that determine the size and rate of growth of the money supply in the economy . Under the Reserve Bank of India, Act,1934 (RBI Act,1934) (as amended in 2016), RBI is entrusted with the responsibility of conducting monetary policy in India with the primary objective of maintaining price stability while keeping in mind the objective of growth.

 Monetary Policy Framework :

The monetary policy framework in India has evolved over the past few decades in response to macroeconomic conditions over the years. The preamble of the Reserve Bank of India (RBI) Act, 1934 , amended in 2016, redefines  the mandate of the RBI as follows :“to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy; to maintain price stability while keeping in mind the objective of growth.

 

The Goals of Monetary Policy are :

  • Price stability 
  • Financial Stability
  • Exchange rate management 
  • Economic Growth 
Based upon the recommendations of Urjit Patel Committee, In Feb 2015, Monetary policy framework agreement was signed between the Reserve Bank of India (RBI) and GOI. This was followed up with the amendment to the RBI Act, 1934 in May 2016 to provide a statutory basis for the implementation of the Flexible Inflation Targeting (FIT) framework.


Flexible Inflation Targeting:

  • The framework provided for the implementation of the flexible inflation targeting framework and then onwards primary objective of RBI is price stability while keeping growth in mind.
  • The amended RBI Act also provides for the inflation target to be set by the Government of India, in consultation with the Reserve Bank, once in every five years. Accordingly, the Central Government has set 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.



RECENT UPDATE  :

Accordingly, in a notification on March 31, 2021, the Central Government, in consultation with the RBI, retained the inflation target for the 5-year period April 1, 2021 to March 31, 2026.

 


Trilemma of RBI :

Along with growth and inflation, Monetary policy also maintains exchange rate. Many a times ,maintaining a balance between Growth , inflation and Exchange rate is said to be the Trilemma of RBI  while balance between growth and inflation is dilemma of RBI.

 

MONETARY POLICY COMMITTEE:

 

The Monetary Policy Process: Section 45ZB of the amended RBI Act, 1934 provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government . Monetary policy is formulated by Monetary Policy committee (MPC).The committee comprises of 6 members including RBI Governor. RBI governor is the chairperson of MPC.MPC comprises of members from RBI and GOI and the decision is based on consensus .REPO rate is exclusively decided by MPC otherwise all other rates except REPO rate are decided by RBI governor.




The proceedings of MPC are confidential and the quorum for a meeting shall be four Members, at least one of whom shall be the Governor and in his absence, the Deputy Governor who is the Member of the MPC. The MPC takes decisions based on majority vote . In case of a tie, the RBI governor will have the second or casting vote. The decision of the Committee would be binding on the RBI. The government may, if it considers necessary, convey its views, in writing, to the MPC from time to time.

RBI is mandated to furnish necessary information to the MPC to facilitate their decision making and if any Member of the MPC, at any time, requests the RBI for additional information, including any data, models or analysis, the same have to be provided, not just to that member but to all members.

 

 

Classification of Monetary Policy:

Monetary policy can be classified as follows:

Classification based upon normal and abnormal economic cycle. Monetary Policy can be classified as :

        unconventional monetary policy

        Conventional Monetary policy


Based upon liquidity position in the market, Monetary policy can be classified as :

        Expansionary

        Contractionary

 

Conventional vs Un-Conventional Monetary Policy :


Conventional monetary policy:

Monetary policy adopted by central bank to attain the defined objectives of economic growth and price stability by using the tools of OMO, VRRR and various interest rates  in the normal course of economic cycle.

Unconventional monetary policy:

 According to RBI’s Deepak Mohanty, “When central banks look beyond their traditional instrument of policy interest rate, monetary policy takes an unconventional character.”

 

Expansionary vs Contractionary Monetary Policy:


Expansionary monetary policy: It increases the money supply /liquidity in the financial system in order to lower unemployment, boost private-sector borrowing and consumer spending, and hence  stimulating the economic growth. It is also said to be cheap money policy. It is also said to be accommodative stance of RBI.


Contractionary Monetary Policy:

Contractionary monetary policy slows the rate of growth in the money supply /liquidity in the financial system or outright decreases the money supply in order to control inflation. It is also said to be hawkish stance. Contractionary monetary policy can slow economic growth, increase unemployment and depress borrowing and spending by consumers and businesses. Money supply during contractionary policy is said to be dear money policy.

 

Nature of Money:


Cheap Money:

During the expansionary monetary policy, money is available at cheaper rates because overall interest rates are low. Cheap money is good for borrowers as it is available at cheaper rates .

Dear Money:

During the Contractionary monetary policy, money is available at costly rates because overall interest rates are high. Dear money is bad for borrowers, as it is available at dearer rates.



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