Monetary policy: Meaning and instruments.

 Q. What is meant by Monetary Policy? Explain the main instruments of monetary policy. 

Ans. Meaning of Monetary Policy: Monetary policy refers to that policy through which central bank of the country (Reserve Bank in India) controls (i) the supply of money, (ii) availability of money, and (iii) the cost of money in order to attain a set of objectives focusing on growth and stability of the economy.

It is an economic policy that manages the size and growth rate of the money supply in the economy. It is primarily concerned with the management of interest rate and the total supply in money in circulation and is generally carried out by central bank.

In the words of G.K. Shaw, “By monetary policy, we mean any conscious action undertaken by the monetary authorities to change the quantity, availability or cost (rate of interest) of money.”

Main instruments of Monetary Policy: 

Monetary policy instruments to credit control is often categorised as Quantitative and Qualitative. Quantitative instruments are applied as non-discriminatory credit policy of the central bank: all sectors of economy are uniformly treated while monetary policy is being pursued. Qualitative instruments are applied as discriminatory credit policy of the government: different sections are treated differently depending on the prevailing situation in the country. Qualitative credit control is also called selective credit control.

I. Quantitative Instruments: Following are the instruments for quantitative credit control:

(1) Bank Rate: Bank rate is an important instrument of credit control. Bank rate is that minimum rate of interest at which central bank of a country is willing to discount the first grade securities of other banks or lends on approved securities. Rise in Bank rate raises the rate of interest and fall in bank rate lowers rate of interest. When bank rate is raised, there is contraction of credit, fall in aggregate demand and hence fall in prices. On the contrary, to check deflation in the country, bank rate is lowered.

(2) Open Market Operations: When the central bank of a country buys or sells securities in the open market is called Open Market Operations. If the credit is to be contracted, the central bank begins to sell securities in the open market. On the contrary, if the central bank wants to expand credit, it begins to buy securities in the open market. In the event of inflation, central bank sells securities in the open market. As a result of it, credit is contracted, aggregate demand goes down and prices tend to fall. On the contrary during depression, the central bank buys securities as a result of which credit expands, aggregate demand increases and prices tend to rise.

(3) Change in Minimum Reserve Ratio: Commercial banks are required to keep a given percentage of their total deposits as cash reserve with the central bank. If the central bank wants to contract credit, it raises the cash reserve ratio. As a result, banks have to keep a larger percentage of their deposits in terms of cash with the central bank. It reduces their cash reserves. Lower cash reserves reduces credit creation capacity of the commercial banks. On the other hand, when the central bank wants to expand credit, it lowers the cash reserve ratio. This leaves the banks with larger cash reserves to create credit.

(4) Change in Liquidity Ratio: Every bank is required to keep a given proportion of its total assets in the form of liquid (or near liquid) assets. It is called liquidity ratio. When the central bank is to contract credit, it raises liquidity ratio. On the contrary, when the central bank is to expand credit, it lowers the liquidity ratio.

II. Qualitative (or Selective) Policy Instruments:

(1) Change in Margin Requirements of Loans: When the central bank feels that the traders are stock piling (collects/hoards) certain commodities as a result of which their prices are rising, then it controls the availability of credit for these goods by changing margin requirement. It means that the margin between the value of the goods pledged as security and the amount of loan is increased. Supposing a person pledges goods worth ₹100 as security with a bank and gets a loan amounting to ₹80. In this example, margin requirement is ₹20, or say 20 per cent. If the margin requirement is raised, then the borrower will have to pledge goods of greater in order to secure loan of a given amount. This way credit is contracted. Supposing, margin requirement is raised to ₹60 only against the security of goods worth ₹100 only. Obviously, if the margin requirement is lowered, there will be expansion of credit. 

(2) Rationing (allocating, distributing) of credit: Central bank is the lender to the last resort to commercial banks. Hence, if it so chooses, it can introduce rationing of credit in order to control credit. Rationing of credit may have any of the four variants:

(i) The central bank can decline loan to a specified category of commercial banks.

(ii) The central bank can reduce the quantum of loans for all the banks.

(iii) Central bank can fix credit quota for different banks.

(iv) Central bank can determine the limit of credit granted to industry and trade. As a result of credit rationing banks become cautious in advancing loans; accordingly flow of credit is restricted.

(3) Direct Action: Sometimes, the central bank may initiate direct action against the commercial banks defying its directives. The central bank may impose strict restrictions on the functioning of defaulting banks including denial of loans.

Quantitative and Qualitative credit control are not ‘either-or’ forms of credit control. These are complementary to each other. Both quantitative as well as quantitative policy instruments may be simultaneously pursued with a view to achieving the objectives of monetary policy.

Macroeconomics: Meaning, scope, limitations

 Q. Define macroeconomics. Explain the scope and limitations of macroeconomics.

Ans. MEANING OF MACROECONOMICS: The term ‘Macro’ is derived from the Greek Word ‘Makros’ which means large. Thus, macroeconomics means economics of large dimension, referring to the economy as a whole.

Macroeconomics is defined as that branch of economics which studies economic activities including economic issues and economic problems at the level of economy as a whole. It focuses on macroeconomic variables like aggregate demand, aggregate supply, general price level, national income and output etc.

DEFINITION OF MICROECONOMICS:
In the words of Boulding, “Macroeconomics theory is that part of Economics which studies the over all averages and aggregates of the system.”

According to Shapiro, “Macroeconomics deals with the functioning of the economy as a whole.”

SCOPE OF MACROECONOMICS: It refers to the issues, problems and parameters of Economics that are included in macroeconomics. Following are the broad areas of study of macroeconomics and subject matter of macroeconomics.

i) Theory of National Income: Macroeconomics studies the concept of national income, its different elements, methods of measurement and social accounting.

ii) Theory of Employment: Macroeconomics also studies problems relating to employment and unemployment. It studies different factors determining the level of employment, viz. effective demand, aggregate supply aggregate consumption, aggregate investment, aggregate saving, etc.

iii) Theory of Money: Changes in demand for and supply of money have considerable
bearing on the level of employment. Macroeconomics studies functions of money and theories relating to it. The system of barking and other financial institutions is also studied in this context.

iv) Theory of General Price Level: Determination of changes in general price-level are the core issues of macroeconotnics. Problems concerning inflation and deflation are the principal issues involved in this context.

v) Economic Growth and Development: Study of problems relating to economic growth or increase in per capita real income forms a part of macroeconomics. Specifically, it studies the growth problem of underdeveloped economies.

vi) Business Cycles: Economic activity always shows ups and downs, it never shows a steady pattern of change for all time to come. This cyclical movement of the economy is better known as business cycle. It is a major macroeconomic issue and an important area of macroeconomics study.

vii) Theory of International Trade: Macroeconomics also studies trade among different countries. Theory of international trade, tariff protection, etc., are subjects of great significance in macroeconomics.

viii) Budgetary Deficit and Fiscal Policy: In the wake of privatisation and globalisation of the world economies, budgetary deficit and the related fiscal policy has emerged as a issue of macroeconomics.

ix) Interest Rates and Monetary Policy: Monetary policy involves monetary measures by the government in terms of changing interest rate with a view to stimulating economic growth and stability.

LIMITATIONS OF MACROECONOMICS: Main limitations of macroeconomics are as under:

i) Dependence on individual units: Several conclusions of macroeconomics are based on the sum total of individual units. In fact, it is not correct, because what is true for individuals may not necessarily be true for the whole economy. For instance, an individual may save in terms of money but if everybody starts saving, the aggregate demand will fall causing reduction in national income.

ii) Heterogeneous Units: Under macroeconomics, hetergeneous units are studied. These units are measured in different ways. It is not possible to express these units in uniform numbers or homogeneous measure.

iii) The composition (ingredients) of structure (manner) of the Aggregate is more important than the Aggregate itself: Macroeconomics studies aggregate but as a matter of fact, it is the composition of the structure of the aggregates which influences an economy more than the aggregate itself. Supposing, price level in 2012 and 2013 remains constant but it does not imply thar no change prices took place in 2013. It is possible that prices of food grains might have fallen in 2013 and that of industrial goods might have risen correspondingly, keeping the general price level constant. Thus, for a proper study of an economy, knowledge of the composition of structure of the aggregate is much essential as the aggregate itself.

iv) Different effects of Aggregates: Another difficulty in the study of macroeconomics is that it does not study the different effects of an aggregate on different sectors of an economy. Macroeconomic tendency (particular way of behaving) has not uniform effect on all sectors of an economy. For example, rise in price level benefits the traders and the industrialists but the wage-earners are the losers.

v) Limited Application: Another limitation of macroeconomics is that most of the models relating to it have only theoretical significance. They have very little use in practical life. Moreover, it is very difficult to measure various aggregates of macroeconomics.

vi) It ignores the contribution of Individual units: Macroeconomics analysis throws light only on the functioning of the aggregates. However, in real life, the economic activities and decisions taken by individual units on private level have their effects on the economy as a whole. Such effects are not known by the study of macroeconomics alone.