Central Bank and Monetary Policy Flashcards
What is money?
Money is a generally accepted medium of exchange
Money can hold intrinsic or fiat value.
What are the properties of money?
- Holds some value either intrinsic or fiat
- Have limited supply
- Difficult to counterfeit
- Preservation of Value
- Easily divisible and additive
What is the function of money as a medium of exchange?
Eliminates the need for double coincidence of wants, thus reducing transaction costs
Transaction Cost is the time spent in trying to exchange goods and services in a barter economy.
What does money serve as in an economy?
- Unit of Account
- Store of Value
- Standard of Deferred Payment
- Distributor of National Income
What is a promissory note?
A financial instrument containing a written and signed promise to repay a sum of money
It typically contains terms such as principal amount, interest rate, maturity date, and issuer’s signature.
What characteristics do government bonds have?
- Debt instrument issued by the government
- Low risk investment
- Components include Face Value, Coupon Rate, and Maturity Period
What is seignorage?
Revenue earned by the RBI from its operations, not intentional but incidental
It covers operational costs, maintenance, and salaries.
What does the Contingent Risk Buffer (CRB) represent?
Risk provisioning made by the RBI to cover unforeseen economic and financial risks
Recommended to be maintained between 5.5% and 6.5% of the RBI’s balance sheet.
What are the three primary reasons for the demand of money?
- Transaction Purpose
- Precautionary Purpose
- Speculating Purpose
What is the Quantity Theory of Money?
The general price level of goods and services is directly proportional to the amount of money in circulation.
It suggests that any increase in money supply leads to a proportional increase in price levels.
What is the formula for the total money supply?
Total Money Supply = High Powered Money (M0) x Money Multiplier (m)
What is the role of the central bank?
It organizes, runs, supervises, regulates, and develops the banking and financial structure of the economy
RBI is India’s central bank, established on April 1, 1935.
What are the functions of a central bank?
- Bank of Issue
- Banker, Fiscal Agent and Adviser to the Government
- Banker to the Banks
- Custodian of Nation’s Foreign Exchange Reserves
What is the significance of the central bank’s monopoly in issuing currency?
- Brings uniformity in note issue
- Imparts prestige to the notes
- Enables effective control over bank money
What is the Reserve Deposit Ratio (rdr)?
The ratio of what a bank holds from the deposits it receives.
It consists of vault cash in banks and deposits of commercial banks.
What is Narrow Money?
M1 = Currency in Circulation + Net Demand Deposits held by Public with Commercial Banks
What is Broad Money?
M3 = M1 + Net Time Deposits of Public with the Banks
It is the most commonly used measure of Money Supply.
What are the components of Government Bonds?
- Face Value
- Coupon Rate
- Maturity Period
What does the term ‘Liquidity’ refer to in the context of money?
Ability to sell without distress
What is the definition of ‘Velocity of Money’?
The number of times money changes hands in a given period
What is the role of reserves in the payment system between banks?
Facilitates the clearing of cheques
Reserves are crucial for smooth transactions between banks and maintaining liquidity.
How does a centralized cash reserve benefit the banking system?
Serves as the basis of a large and more elastic credit structure
Centralized cash reserves allow banks to manage credit creation effectively.
What are approved securities?
Government Bonds, Gold Reserves, and Permissory Notes
These are securities that can be discounted by the central bank.
What are the quantitative methods of credit control used by the central bank?
Control the cost and availability of credit
These methods include adjusting interest rates and reserve requirements.
What are the qualitative methods of credit control?
Influence the use and direction of credit
These methods target specific sectors or purposes for lending.
What is Expansionary Monetary Policy?
Increases the supply of money by making credit easily available
This policy is typically used during periods of recession.
What is Contractionary Monetary Policy?
Decreases the supply of money to tackle inflation
This policy raises interest rates to control excessive money supply.
What are Open Market Operations (OMO)?
Buying and selling of government securities to control money supply
OMOs are a primary tool for influencing liquidity in the banking system.
What is Cash Reserve Ratio (CRR)?
Proportion of bank’s net demand and time liabilities kept in cash with RBI
Currently, CRR is set at 4%.
What is Statutory Liquidity Ratio (SLR)?
Proportion of NDTL to be maintained in safe and liquid assets
SLR ensures trust in the banking system.
What is Liquidity Adjustment Facility (LAF)?
Facility for banks to manage surplus or deficit liquidity
LAF includes Repo Rate for lending and Reverse Repo Rate for borrowing.
What is the purpose of the Marginal Standing Facility (MSF)?
Provides emergency funding for banks with exhausted borrowing options
MSF is available to Scheduled Commercial Banks and includes a penalty for SLR violations.
What does the Market Stabilisation Scheme (MSS) aim to achieve?
Withdraw excess liquidity by selling government securities
MSS is used when traditional tools are insufficient.
What is Moral Suasion in the context of monetary policy?
Persuasion and request to influence bank lending behaviors
It is a qualitative tool for managing credit flow.
What does Rationing of Credit involve?
Limiting maximum loans and fixing ceilings for specific categories
It ensures credit flows to priority sectors.
What happens when margin requirements for loans increase?
Discourages credit flow to speculative activities
This is a tool to control inflation.
