Page 246 - DECO402_Macro Economics

Unit-27: Monetary Policy

bank. Such type of policy just changes the deposits kept by the banks in form of securities Notes
to active deposits. Government securities kept in the portfolio of the banks are substituted
in place of loans. But there is no change in total deposit and money supply of the bank. But
through it, total expense increases, because banks lend money to borrowers. In this manner
restrictive monetary policy of the central bank becomes ineffective.
Then, when banks sell government securities to central bank, their prices fall in the market
and rate of interest on them increases by it general interest rate structure in the market
increases. But by fall of prices of securities banks will have capital losses and banks will not
like to suffer those. It depends on it that whether banks hope that fall in securities prices (or
increase in interest rates) is short term or is going to last long. If banks hope that decline in
security prices will stay for some time only then instead of selling those (securities) at capital
loss, they will like to keep them. At the other side if they hope that decline in securities prices
will go on for some time then for giving loans to the customers at high rates they will sell
the securities and will fulfil the capital- loss by sale of securities by giving the loans at high
interest rates. But once demand for loans will reduce then banks will be able to buy back
the government securities at prices lower than that at which they had sold them and will
again be in profit in this deal. In this way, commercial banks’ policy of portfolio adjustments
increases the velocity of net money despite an expensive monetary policy and as a result
expensive monetary policy is left ineffective.
b. Role of non-Banking financial Intermediaries: NBFIs stop the money supply controlling capacity
of monetary policy in two ways. First, they sell securities for giving loans and like commercial
banks, increase the velocity of money in the same way as has been described above. Secondly,
under expensive monetary policy as the rate of interest increases on securities, in order to
achieve more reserves from the savers financial intermediaries keep increasing interest rates
of deposits with them. It encourages savers that they give their inactive money to these
intermediaries by which their loan capacity increases further. In this way these intermediaries
are successful in increasing the velocity of money as a result of which expensive credit policy
is left incapable.
c. Methods to make better use of available money supply: Many methods have been devised for
better use of available money supply which makes restrictive monetary policy ineffective.
Some such methods are there like development of better methods of fund collection of sales
financial institutions; in comparison to commercial banks more loan taken by NBFI from the
public etc. By obtaining funds from various sources of commercial banks, such institutions,
even under restrictive monetary policy, are successful in increasing the velocity of available
supply of money.
2. Discriminatory: Expensive monetary policy has discriminatory influence on various fields of
economy. It is said that those firms which depend on internal sources under financial system,
they are not influenced by restrictive monetary policy. At the other side, only those firms are
influenced which depend on banking system for funds. Especially it is understood in relation
to expensive monetary policy that it works against the traders, because they are extremely
sensitive towards changes in credit costs reason for which is that they cannot take credit
risk and are ageist residential construction and some types of state and local government
expenditure. It can not only slow their expenditure but may even stop it.
3. Threat to Credit Market: If central bank strictly controls credit market and investors expect
interest rates to rise continuously then it may end loan sum reserves of credit market.
Consequently securities may not be sold and credit market may stop working.
4. Threat to solvency of NBFIs: Strong restrictive monetary policy, through fast increasing
interest rates, may create a threat to solvency of savings banks and savings and loan

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