Page 223 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes
Did u know? Monetary policy is the most significant factor in explaining the slow rates of
economic growth in our national economies. It can explain the downturn in South East
Asia, including why China is not suffering from the fallout.

Money is the power that drives an economy. If the central bank regulates money appropriately,
it can regulate the performance of the whole economy. However, if the central bank fails to do
that, the whole economy will suffer for it. Economies like Europe, Australia, New Zealand, USA,
Canada, Russia, and more recently, South East Asia have benefited a lot from it.

Caselet How Does Monetary Policy Impact Individuals

I interest rates.
n recent years, the policy had gained in importance due to announcements in the

Earlier, depending on the rates announced by the RBI, the interest costs of banks would
immediately either increase or decrease.
A reduction in interest rates would force banks to lower their lending rates and borrowing
rates. So if you want to place a deposit with a bank or take a loan, it would offer it at a
lower rate of interest.

On the other hand, if there were to be an increase in interest rates, banks would immediately
increase their lending and borrowing rates. Since the rates of interest affect the borrowing
costs of corporates and as a result, their bottomlines (profits), the monetary policy is very
important to them also.
But over the past 2-3 years, RBI Governor Bimal Jalan has preferred not to wait for the
Monetary Policy to announce a revision in interest rates and these revisions have been
when the situation arises.

Since the financial sector reforms commenced, the RBI has moved towards a market-
determined interest rate scenario. This means that banks are free to decide on interest
rates on term deposits and loans.
Being the central bank, however, the RBI would have a say and determine direction on
interest rates as it is an important tool to control inflation.

The bank rate is a tool used by RBI for this purpose as it refinances banks at this rate.
In other words, the bank rate is the rate at which banks borrow from the RBI.

Source: http://www.rediff.com/money/2002/apr/25tut.htm

Self Assessment

State whether the following statements are true or false:
1. High employment and price stability are two of the main objectives of the monetary
policy.
2. Monetary policy operates on the supply side and not on the demand side of the goods
market.

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