Monetary and Credit Policy

Definitions:
The -strategy of influencing movements of the money supply and interest rates to affect output and inflation
The actions of a central bank that determine the size and rate of growth of the money supply. which in turn affects interest rates.
A macroeconomic policy tool used to influence interest rates, inflation, and credit availability through changes in the supply ofmoriey available in the economy
An attempt to achieve broad economic goals by the regulation of the supply of money
The regulation of the money supply and interest rates by a central bank in order to control inflation and stabilise currency
Monetary polic is the process of managing a nation's money supply to achieve specific goals-such as constraining inflation, achieving full employment etc.
Monetary olicy is made by the central bank to manage money supply supply to achieve specific goals-such as constraInIng ination, maintaining an appropnate exchange rate, enerating jobs and economic growth. Monetary policy involves changing interest rates, either directly or indirectly through opeJl market operations, setting reserve requirements. or trading in foreign exchange markets.
Monetary Policy
The use by the Central Bank of interest rate and otnel-instruments to influencc money supply to achieve certain macro economic goals is known as monetary policy. Credit policy is a part of monetary policy as it deals only with how much and at what rate credit is advanced by the banks. Objectives of monetary policy are:
accelerating growth of economy
price stability
exchange rate stabilization
balancing savings and investment
Generating employment and
Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy: expansionary policy increases the total supply of money in the economy as in 2008-09 all over the world including India to beat recession/slowdown; and a contractionary policy decreases the total money supply by tightening credit conditions (2005-07 in India). Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy has the goal of raising interest rates to combat inflation.
The Reserve Bank of India announces the Monetarv and Credit Policy twice a year-October and April October policy is called busy season as it is the harvesting time for the kharif season which used to account for the major part of India's agricultural operations. Credit policy indicates and influences the supply of money in the economy and the rate of interest charged by banks. The policy also contains an economic overview and presents forecasts.
However, monetary policy has become dynamic in nature as RBI reserves its right to alter it from time to time; depending on-the state of the economy. RBI conducts a quarterly review of the monetary policy.
The instruments of monetary policy are bank rate, SLR, CRR and open market operations by the RBI on the basis of repo and reverse repo rates (buying and selling of Government securities in the open market, short term, to regulate money supply). Monetary policy works through influencing the cost and availability of credit and money.
According to Mr Tarapore, former Deputy Governor of the RBI, CRR was increasingly becoming a 'sunset' instrument of monetary and credit policy as RBruepends more on open market operations for liquidity adjustment. However, the statement was proved to be premature as the RBI relies more and more on adjusting CRR rates to regulate money supply and deal with inflation. CRR is currently 5%( July 2009).
The tools available for the central bank to achieve the above ends are the following
Bank rate
Reserve ratios
Open market operations
Intervention in the forex market and
Moral suasion
Bank rate
Bank Rate is the rate at which RBI lends long term to commercial banks. Bank Rate is a tool which RBI uses for managing money supply and credit. Any revision in Bank Rate by RBI is a signal to banks to revise deposit rates as well as prime lending rate( PLR is the rate at which banks lend to the best customers). It stands at 6% presently 92009 July). It is a blunt instrument and is usually not changed unless the demand is extraordinary. In fact. in the recent liquidity crisis-2008-09-too, bank rate remained unchanged
Reserve Requirements
In economics, fractional-reserve banking is the near-universal practice of banks in which banks keep a fraction of the total deposits managed by a bank as reserves and are not to be lent. The reserve rations are periodically changed by the RBI. The reserve requirement (or required reserve ratio) is a bank regulation, that sets the minimum reserves each bank must hold as a part of the deposits. These reserves are designed to satisfy. various needs like providing loans to the Government (SLR) and inflation management (CRR). They are in the form of RBI approved securities (SLR) kept with themselves or cash that is kept with the RBI (CRR).
Statutory liquidity ratio (SLR)
It is the portion of time and demand liabilities of banks that they should keep in tne form of designated liquid assets like goveernment and other RBl-approved securities public sector honds : current account balances with other banks and gold. SLR is aimed at ensuring that the need for government funds is partly but surely met by the banks. SLR was progressively brought down from 38.5% in 1991 to 24% (2009) since the reforms began in early 90's.
Banks need more liquidity to lend at lower rates in the current economic downturn. Therefore, RBI reduced the SLR by 1% to 24% late 2008. SLR .is a blunt instrument and was unchanged for more than a decade and half till it was lowereq in 2008.
The Reserve Bank of India ACt, 1934 and the Banking Regulation Act, 1949 fixed the floor and cap on SLR at 25% and 40% respectively. But the amendment made in these statutes in 2006 removed the limits-lower and upper. RBI has, as a result, the freedom to fix the SLR at any rate depending on the macro economic conditions. The amendment was an enabling one.
CRR
CRR is a monetry tool to regulate money supply. It is the portion of the bank deposits that a bank should keep with the RBI in cash in cash form. CRR deposits earn no interest.
The Reserve Bankf of India Act, 1934 and the Banking Regulation Act. 1949 fixed the floor and cap on CRR at 3% and 20% respectively. But the amendment made in these statutes removed the limits-lower and upper. RBI has, as a result, the freedom to fix the CRR at any rate depending on the macro economic conditions. The amendment was an enabling one.
CRR is adjusted to manage liquidity and inflation The more the CRR, the less money available for leanding by the banks to players in the economy. CRR was 15% in 1991 and today it is 5% If inflation is high, money supply needs to be taken out and so CRR is generally increased. But in a regime of moderate inflation, low CRR is in place.
RBI increases CRR to tighten credit and lowers CRR to expand credit. In the current downturn. CRR has been reduced to 5% It was 8.75% in 2008 to beat inflation that touched about 13% Inflation needed to be controlled by a variety of means one of which was CRR.
CRR as a tool of monetary policy is used when there is a relatively serious need to manage credit and inflation. Otherwise, normally. RBI relies on open market operations for liquidity management.
Open Market Operations Of RBI
OMOs of the RBI can be described as purchases and sales of government securities and certain other securities in the open market (open market essentially means banks and financial institutions) by the RBI in order to influence the volume of money and credit in the economy. Purchases of government securities injects money into the market and thus expands credit; sales have the opposite effect-absorb excess liquidity and shrink credit. Open market operations are RBI's most important and flexible monetary policy tool. Open market operations are RBI's most important and flexible monetary policy tool. Open market operations do not change the total stock of government securities but change the proportion held by the RBI, commercial and cooperative banks.
Ready Forward Contracts (Repos)
It is a transaction in which two parties agree to sell and repurchase the same security. Under such an agreement the seller sells specified securities with an agreement to repurchase the same at a mutually decided future data and a price. Similarly, the buyer purchases the securities with an agreement to resell the same to the seller on an agreed data in future at a predetermined price.
In India, RBI lends on a short term basis to banks on the security of the government paper(repo). Banks undertake to repurchase the security at a later date-over night or few days. RBI charges a repo rate for the money it lends. It is 4.75% presently (2009 July)
reverse repo is when RBI borrows from the market (absorbs excess liquidity) with the sale of securities and repurchases them the next day or after a few days. The rate at which it borrows is called reverse repo rate as it is the reverse of the repo operation. Reverse repo rate presently is 3.25% (July 2009)
The Repo/Reverse Repo transaction can only be done at Mumbai and in securities as approved by RBI (Treasury Bills, Central/State Govt securities). RBI uses Repo and Reverse repo as instruments for liquidity adjustment in the system.
Repo and reverse repo rates are known as policy rates and are used as signals to the financial system to adjust their lending operations.
Selective Credit Controls
Certain businesses can be given more and certain others may get less credit from banks on the orders of the RBI. Thus, selective credit controls can be imposed for meeting various goals like discouraging hoarding and black-marketeting of certain essential commodities by traders etc by giving them less credit. Either credit can be rationed or interest rate can be hiked by RBI as a part of SSCs. In SSCs, the total quantum of credit does not change, but the amount lent and the cost of credit may be changed for specific sector or sectors.
Moral suasion
A persuasion measure used by Central bank to influence and pressure, but not force, banks into adhering to policy. Measures used are closed-door meetings with bank directors increased severity of inspections. discussions, appeals to communit, spirit etc.
Recently the RBI Governor appealed to banks not to raise rates even though the central hank was following a tight money policy.
The Growing Importance of Monetary Policy
The growing importance of monetary policy in the management of the economy during the era of globalization is a fact. Generally, democratically elected governments resist to use fiscal policy to fight inflation as it requires government to take unpopular actions like reducing spending or raising taxes. The option of cutting indirect taxes is a iimited one. Political realities favor a bigger role for monetary policy during times of inflation and deflation/disinflation.
Fiscal policy may be more suited to fighting unemployment as the government can step up spending to create public works and in the process jobs: while monetary policy may be more effective in fighting inflation/deflation. There is a limit to how much monetary policy can do to help the economy during a period of severe economic crisis.
The monetary policy remedy to economic decline is to increase the amount of money In circulation by cutting interest rates, for example, during the 2008-09 economic downturn world wide including India.
But once interest rates reach zero, the central bank can do no more-economists call it the "liquidity trap," what Japan did during the late 1990s. That is, liquidity is trapped in banks-banks do not want to lend as credit may turn into bad asset. Businessed do not want to borrow as demand has slumped. It is a classical case of liquidity trap and was seen all over the world including India in the current downturn-2008-09.
With its economy stagnant and interest rates near zero, many economists argued that the Japanese government had to resort to more aggressive tiscal policy, if necessary. running up a sizable government deficit to spur renewed spending and economic growth. Monetary policy policy proved to be of no real value then.
Monetary policy has grown from simply increasing the monetary supply enough to keep up with both population growth and economic activity. It must now take into account such diverse factors as:
Signals to the economy by way of rate and reserve adjustment
exchange rates;
credit quality;
international capital flows of money on large scales:
With globalization and the increase in the flow of funds- highly speculative in character monetary policy acquires unprecedented importance for the country. The following will illustrate the point further that globalization challenges monetary policy:
Management of the exchange is a crucial pan of the monetary policy as exchange rate dictates foreign flows- inflows and outflows. It has a close bearing on money supply and inflation and interest rates. For instance, if foreign inflows flood the country. in order to maintain its monetary stability, RBI has buy the foreign currency to save the rupee from excessive appreciation. The rupee that is printed has to be sucked out with Government securities as otherwise it will be inflationary.
The Market Stabilization Bond Scheme in India was started as a sterilization sttempt in 2004. Such sterilization ca'n be expensive as The money so .sucked out costs by way of the interest paid on it Thus, the purpose of stemming rupee appreciation leads to excess of money supply which inflates the economy and so needs to be sterilised with the direct intervention( selling MSBs) or hike in interest rates and CRR- the latter hurts growth even as they reduce inflation. The latter was seen in India in the 2006-08 period.
Thus, monetary policy acquires enormous importance during globalization.
Market Stabilization Bonds.
In 2004. REf began floating Government securities and T-Bills. as a part or the Market Stabilization Scheme, to absorb excess liquidity from the market. The excess liquidity is· the result of RBI buying dollars from the market. MSS is a sterilization effort of the central hank. The normally available government securiti'es are not enough lor the RBl to suck out the huge rupee supply (printed money called base money or reserve money or high powered money) that was caused for buying dollar. Therefore, the MSS was started.
Developing countries and Monetary Policy
Developing countries have problems operating monetary policy effectively. The primary difficulty is that fiscal policy of the Government sets priorities and the Central bank is not actively involved in decisions related to money supply through borrowings. The welfare schemes; foreign trade policy, tax policy etc are the privilege of the central government and the central bank largely acts to support the same. Further, few developing countries have deep markets in government debt. Thus, the OMOs have limited value.
In India. situation is improving with RBI being given importance after economic reforms started early in the 1990's. The introduction of WMAs for the central government: FRGM All 2003 etc gave autonomy to the RBI and a..consultative role to it.
Interest rates and their significance
Interest rates are the rates offered to money that is deposited in the banks: rates offered for investment in bonds; rates at which money is borrowed from banks and financial institutions: and rates charged from the borrowers etc.
Savers want higher interest rate while investors want the cost of credit to be low. There has to be a balance. The determinants of interest rates are:
Inflation- the higher the inflation, the higher the interest rates because the same money invested in commodities should not fetch more, because of the inflation:
Need for growth :Iower interest· rates reduce cost of credit and facilitate investment for growth
Promotion of savings
Government's need to borrow: the magnitude of government's borrowing programme also determines interest rates. The more the borrowing, the higher the interest rates.
Need to generate demand. :as interest rates come down, consumer demand for credit goes up and there will be a stimulus for growth
Global trends as we need to retain foreign funds
Deregulation of Interest Rates
As a part of banking sector reforms, interest rates have been deregulated. The rationale is that-banks can adjust rates quickly according-to market conditions~ financial innovations should be facilitated; populism through regulation can be prevented~ competitive rates can be good for savers and investors; global alignment is possible more dynamically: etc. RBI however uses repo rates and CRR adjustments to influence interest rates.
Presently, bank rate is 6%( 2009) and prime lending rate (PLR) is about 12% PLR being the rate at which corporates with excellent credit record are lent.
Interest rates came down' for a decade from 1994 to promote growth: dropped further since the beginning of the current decade for more growth; climbed up since 2004 till mid-2008 to beat inflation; and dropped relatively since mid-2008 as inflation eased and growth requirements demand that interest rates be softened.
Floating and Flexible Rates of Interest
There are two types of interest rate-fixed and floating. If they are offered together (when they co exist), it is called flexible interest rate regime. Floating interest rates are linked to an underlying benchmark rate. In other words, the interest rate offered 'floats' in relation to the interest rate of a government security instrument of similar duration (5 years or 10 years maturity etc) as determined by the market. That is, floating rates of interest are basically market driven rather than 'fixed'. The effective rate is adjusted on a quarterly or semi-annually or annually.
Inflation targeting
Under this policy approach the target is to keep inflation in a particular range or at a particulat level. Government and the RBI agree on convergence between the fiscal and the monetary policies to achieve the common foal. RBI is given autonomy to mange inflation while the government agrees to have a fiscal policy that will contribute to price stability-for example, not borrow excessively etc.
This monetary policy approach was pioneered in New Zealand. It is currently used in the Eurozone. australia, Canads, New Zealand, Sweden, South Africa, Norway and the United Kingdom. (See Chapter on Inflation for more)
Reserve Bank of India
The central bank of the country is the Reserve Bank of India (RBI). It was established in 1935 with a share capital of Rs. crores on the basis of the recommendations of the Hilton Young Commission. The share capital was entirely owned by private shareholders in the beginning. The Government held shares of nominal value of Rs. 2,20,000.
Reserve Bank of India was nationalised in the year 1949. The general superintendence and direction of the Bank is entrusted to Central Board of Directors of 20 members, the Governor and four Deputy Governors, one Government official from the Mil1lstry of Flrlance, ten nommated Directors bYthe Government to give representation to important elements in the economic life of tile country and four nommated Directors by the CentrallJovemment to represent the four local Boards with the headquarters at Mumbai, Kolkata. Chennai and New Delhi
The Reserve Bank of India Act, 1934 came into effect in 1935. The Act provides the statutory basis of the functioning of the Bank.
Reserve Bank of India
Functions
The Reserve Bank of India Act of 1934 entrust all the important functions of a central bank the Reserve Bank of India.
Bank of Issue
Under Section 22 of the Reserve Bank of India Act. the Bank has the sole right to issue bank notes of all denominations. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the Government. The Reserve Bank has a separate Issue Department which is entrusted with the issue of currency notes.
RBI shauld maintain gald & fareign exchange reserves af Rs. 200 cr, af which Rs. 115 cr. should be in gald. Hawever, the amaunt at currency that the RBI can print depends upon the nceu or the economy. The only restriction is the systemic one it shauld nat create instability with too much or too. less of money supply. Money supply shauld have a carrespandence to. the goods in the economy and the rates of growth.
Banker to Gavernment
The second important function of the Reserve Bank of India is to act as Government banker, agent and adviser. The Reserve Bank is agent of Central Government and of all State Governments in India. the Reserve Bank has the obligation to transact Government business, to receive and to make payments on behalf of the Government and to carry out their other banking operations. The Reserve Bank of India helps the Government - both the Union and the States to raise. the Bank makes ways and means advances to the Governments. It gives loans and makes advances to the States and local authorities. It acts as adviser to the Government on all monetary and banking matters.
Bankers' Bank and Lender of the Last Resort
The Reserve Bank of India acts as the Bankers' bank.
The scheduled banks can borrow from the Reserve Bank of India on the basis of eligible securities by rediscounting bills of exchange. CRR deposits of banks are kept with the RBI.
Since commercial banks can always expect the Reserve Bank of India to come to their help in times of banking crises, the Reserve Bank is the lender of the last resort.
Controller of Credit
The Reserve Bank of India is the controller of credit i.e. it has the power to influence the volume of credit created by banks in India. It can do so through changing the instruments available to it (see above). According to the Banking Regulation Act of 1949, the Reserve Bank of India can ask any particular bank or the whole banking system not to. lend to particular groups or persons. Since 1956, selective cantrols af credit are increasingly being used hy the Reserve Bank.
The Reserve Bank of India is armed with many more powers to control the Indian money market. Every bank has to get license from the Reserve Bank of India to do banking business within India. the license can be cancelled by the Reserve Bank of certain stipulated conditions are not fulfilled. Every bank will have to get the permission of the Reserve Bank before it can open a new branch. Each scheduled bank must send a weekly return to the Reserve Bank showing, in detail, its assets and liabilities. This power of the Bank of call for information is also intended to give it effective control of the credit system. The Reserve Bank has also the power to inspect the accounts of any commercial bank.
RBI can thus impact on credit and money supply - quantity and quality- with the lools and powers available to it. In the period since global recession set in, late 2008, RBI is following expansionary policy to make credit more in quantity as well as cheaper so that more can be lent and borrowed to stimulate the economy. All the rates and reserves are reduced except bank rate.
Custodian of Foreign Reserves
The Reserve Bank of India has the responsibility to act as the custodian of India's reserve of international currencies. It takes up operations in the forex market to stabilize the exchange rate of rupee and ensure that there is no speculation and there is order. To be able to do so ·effectively. it holds forex reserves which it acquires from the market (purchases). It has $253b of forex r·eserves (2009 July) which includes foreign currency assets. gold and IMF's SDRs). SDRs are negligible: gold is about 3-4% ; and the rest is foreign cur:rency of which the US dollar is the reserve currency.
Supervisory functions
In addition to its traditional central banking functions, the Reserve bank has certain non-monetary functions of the nature of supervision of banks and promotion of sound banking in India. The Reserve Bank Act 1934. and the Banking Regulation Act, 1949 have given the RBI wide powers or supervision and control over commercial and co-operative banks, relating to licensing and establishments. branch expansion, setting reserve ratios etc.
Promotional functions
Since Independence, the range of the Reserve Bank's functions has steadily widened. The Bank now performs a variety of developmental and promotinal functions. The Reserve Bank was asked to promote banking habit, extend banking facilities to rural and semi-urban areas. and establish and promote new specialised financing agencies. Accordingle, the Reserve banks has helped in the setting up of the IFCI and the SFC; the Industrial Development Bank of India in 1964, the Agricultural Refinance Corporation of India in 1963 and the Industrial Reconstruction Corporation of India in 1972. these institutions were set up directly or indirectly by the Reserve Bank to promote saving habit and to mobilis savings, and to provide industrial finance as well as agricultural finance. The RBI has set up the Agricultural Refinance and Development Corporation to provide long-term finance to farmers. NABARD was set up in 1982.
Functions of central bank, in sum
monopoly on the issue of banknotes
the Government's banker
bankers' bank
Lender of Last Resort
manages the country's foreign exchange and gold reserves
regulation and supervision of the banking industry;
setting the official interest rate - used to manage both inflation and the country's exchange rate.
The central bank's main responsibility is the management of monetary policy to ensure a stable economy, including a stable currency. It aims to manage inflation (rising average prices) as well as deflation (falling prices). It is the lender of last resort, and will assist banks in cases of financial distress (see also bank runs).
Furthermore, it will hold foreign exchange reserves and official gold reserves, and will often have some influence over exchange rates. some exchange rates are managed, some are market based (free float) and many are somewhere in between ("managed float" or "dirty float").
Typically a central bank controls certain types of short-term interest rates (repo and reverse repo rates) These influence the stock- and bond markets as well as mortgage and other interest rates.
RBI Act amended 2006
Government made amendments to RBI Act 1934 and Banking Regulation Act for allowing the apex bank to have more flexibility to fix the Cash Reserve Ratio (CRR). It helps to remove the floor and cap on statutory liquidity ratio (SLR) and CRR to provide flexibility to RBI to manage liquidity.
Greter flexibility in setting the CRR would make it possible for the RBI to encourge greter credit off-take. This would result in better liquidity management in the system.
Autonomy for RBI
RBI being the architect of the monetary policy requires autonomy to be effective.Advoceates of central bank independence argue that a central bank which is too susceptible to political direction or pressure may encourage economic cycles ("boom and bust"), as politicians may be tempted to boost the economy in advance of an election, to the detriment of the long-tenn health of thc economy. In addition, it is argued that an independent central bank can run a more credible monetary policy without populist consiqerations.
The recent measures to make RBI independent are
replacement of adhoc treasury bills with WMA from 1997
FRBM Act empowers RBI with autonomy- no primary borrowing from 1-4-2006.
The arguments in favour of autonomy are:
monetary stability which is essential for the efficient functioning or the Iliodern economic system can be best achieved irprofessional Central bankers with the long term perspective are given charge. Otherwise, politicalle·adership may be tempted to populism
without such autonomy, government tends to he profligate with its policies of automatic monetization
monetary credibility is high in public perception if professionals manage it.
The arguments against are:
democratic systems are run with Parliament and Cabinet making all importanl policies
monetary policy is an integral policy of the overall economic policy and so RBI has to subordinate itself to the larger objective.
The best course is to have a middle path where autonomy should be linked to performance like in the policy of inflation targeting' where the central bank should justify its autonomy with performance in the field of management of prices at reasonable levels.
Money Supply
This refers to the total volume of money circulating in the economy. Money supply can be estimated as narrow or broad money.
M1 equals the sum of currency with the public and demand deposits with the banks. It is the narrow money.
M3 or the broad money concept, as it is also known includes time deposits (fixed deposits), savings deposits with post office saving banks and all the components of M1.
Monetary and fiscal policy
Two important tools of macroeconomic policy are monetary policy and fiscal policy. Both have same goals. Fiscal policy is made by Government while the architect of monetary policy is the central bank.
The monetary policy aims to maintain price stability, exchange rate stability, full employment and economic growth.
Reserve Bank of India can increase or decrease the supply of money as well as interest rate. carry out open market operations, control credit and vary the reserve requirements to achieve these objectives.
Monetary policy is different from fiscal policy as the former brings about a change in the economy by changing money supply and interest rate, whereas fiscal policy is a broader tool with the government. Fiscal policy relates to taxation and other means of raising money and setting expenditure priorities. It can be used to direct economic growth in a desirable direction: provide social welfare; fight recession (pump prime the economy) and create employment.
For instance, at the time of recession the government can increase expenditures or cut taxes in order to generate demand, or do both .. The three fiscal stimulus packages given by governent since October 2008 and the Union Budget 2009010 are the examples of stimuli where tax reliefs and public investment are the main features.On the other hand, the government can reduce its expenditure when the economy is doing well.
Supply side economics is resorted to boost economy- it means cutting taxes to boost consumption and investment. It is also called Reaganomics, after the former US President Ronald Reagan.
Monetary policy also seeks to facilitate growth by cutting interest rates.
The two policies need to work for convergence as their objectives are the same. The 1997 initiative to replace ad hoc treasury bills with WMAs is an example of the harmonization of the two policies. Another examp"le is the FRBM Act.
If the fiscal policy borrows excessively, the resultant higher interest rates and innation can not be managed by the RBI. Therefore, the need is for convergence. The challenge to enable convergence between the two has never been felt more than it is since the global meltdown of 2008 when the government is printing money to pump prime th.. e economy and the RBI is under pressure to manage the interest rates and the inflation that may come up in future.
Words
Monetary base is also called the reserve money. It is the sum of the currency in the hands of the public and the currency commercial banks keep as reserves with the central bank {RBI). It is also known as High-powered Money. In sum it is: Reserves + Currency with the public
Prime Lending Rate (PLR) is the rate at which banks lend to the best customers.
Basis point: Changes in interest rates and other variables are expressed in tcrms of basis points to magnify and express the importance of changes. One basis point is 1% of 1%.
LAF: Liquidity Adjustment Facility (LAF) is the same as repos but the rate at which the transactions are done is the market rate and is not fixed.
Quantitative easing
The term quantitative casing describes an extreme form of monetary policy used to stimulate an economy where interest rates are either at or close to zero. Central bank uses unconventional means, other than the usual monetary policy tools, to flood the the financial system with new money through quantitative easing.
In parctical terms, the central bank purchases financial assets. including treasuries and corporatc bonds, from financial institutions (such as banks) using money it has created.
Central Banks all over the world have used quantitative easing to overcome the liquidity crisis since the fall of Lehman Brothers in 2008 September when credit froze.
Credit crunch / liquidity crunch/ liquidity crisis
Credit / Liquidity crunch refers to a state in which there is a short su ply of money to klld to businesses and consumers and interest rates are high. It may happen when the government borrows heavily and there is crowding out of the corporate sector.
It may also refer to a serious crisis of confidence in the financial system following failurcofbanks and Fls( Lehman Brothers 2008) when banks refuse to lend to even genuine businesses faring default and credit turning into bad debt.
In such a situation, banks may have liquidity but would not lend as fear grips them.
Monetary expansion / easing / stimulus
The current global recession is being overcome through stimulus packages of which the monetar stimulus by the central banks is an important part. It operates through reduction of rates - policy rates of repo and reverse repo; and reserve ratios- SLR and CRR. The goal is to make enough liquidity available to the banks so that they reduce the rates and lend more It)r Illakillg more investment possible and growth can be revived.
Another aspect of the monetary stimulus we have witnessed is the quantitative easing.
In countries like Japan, all these efforts have not yielded results as liquidity trap is the best descripition for the recessionary situation there. In India, however, the stimulus packages is working.