Macro 1to3 English Colour

Download as pdf or txt
Download as pdf or txt
You are on page 1of 8

CHAPTER-1 Open Economy- An economy which has economic

relationship with other countries


Introduction to Macro Economics
CHAPTER-2
Emergence of Macro Economics
NATIONAL INCOME ACCOUNTING
Macro economics emerged as a separate branch of
study after the Great Depression of 1929.Depression is a National Income:
period in which all the economic activities are at the low
level. J M Keynes studied the situation and wrote his National Income is the sum total of the money
famous book “The General Theory of Employment, value of all final goods and services produced by country
Interest and Money” in 1936..He studied the working of the during a financial year. It is the income of the people of a
economy as a whole and the interdependence of the nation during a year.
different sectors of the economy. This approach is referred Final Goods:
to as the Keynesian Revolutuon.
Goods used for final consumption and not again
Great depression of 1929 subjected to the process of production is called final
➔ The output and employment levels in the countries goods. Final goods itself are of two types- consumption
of Europe and North America fall by huge goods and Capital goods.
amounts. ➢ Consumer or Consumption Goods:
➔ It affected other countries of the world as well. Goods that are not subjected to a further process
Demand for goods in the market was low, of Production and used by the Consumer directly are
➔ Many factories were lying idle, workers were called consumer or consumption goods. Consumer goods
thrown out of jobs. are two types. They are

➔ In USA,from 1929 to 1933, unemployment rate Durable Goods: Long lasting goods are known as durable
rose from 3 per cent to 25 per cent. goods. Eg: TV, Car

➔ Over the same period GDP of USA fell by about Non Durable Goods: Goods that lasts only short period of
33 per cent. time. Eg: Food items like milk, vegetables etc

➔ These events made economists think about the ➢ Producer Goods or Capital Goods:
functioning of the economy in a new way. Goods once produced and which can be used again
➔ That leads to the emergence of a new branch of for Production are called Producer or Capital Goods.
economics (Macro Economics) Eg. Machines, buildings.

Sectors of the economy Intermediate Goods:Goods used as an input for producing


other goods are called Intermediate goods. Eg. Wood in a
Household Sector paper factory, leather in a shoe factory.

Firms Investment:Investment means Capital formation. It is the


addition to the existing stock of Capital. It is a Flow
Government Sector variable.
External Sector. Gross Investment: Total durables or Capital goods
Economic Agents produced during a year in an economy are called Gross
Investment. It is of three types.
Economic units or economic agents, means those
individuals or institutions which take economic decisions. ➔ Inventory Investment-The increase in the
They can be inventory value of a firm during a year is called
inventory investment.
Consumers
➔ Fixed Business Investment -Addition made to
Producers existing machinery, factory, buildings, equipments
etc.
Government
➔ Residential Investment-Addition made to
Corporation
residential facilities is residential investment.
Banks, etc
Net Investment: The addition to the existing stock of capital
Closed Economy- An economy which has no economic is net investment. It is the new capital formation.
relationship with other countries.
Net Investment = Gross Investment – Depreciation

Dileepkumar Puthiyatath & Sreejith Ponnambath, EKNS GHSS Vengad


Depreciation or Consumption of Fixed Capital: Inventories are treated as Capital, There fore change in the
inventory of a firm is treated as Investment
The loss of value of fixed assets due to normal wear
and tear is called Depreciation. It is also called Net Indirect Tax(NIT): Indirect Tax are the tax imposed by
Consumption of fixed capital. the government on goods and services. Sometimes
government gives Subsidies to encourage producers. The
Stock Variable :A Variable that can be measured at a point difference between Indirect Tax and Subsidies is
of time is called a stock. It is a static concept. It has no time called Net Indirect Tax.
limit. It is measured at a particular point of time.
Eg. Wealth, Capital, Inventory. Net Indirect Tax = Indirect Tax – Subsidies.

Flow Variable :A Variable that is measured in a specific Transfer Payment or Transfer Income or Transfer
period of time is called a flow. It is a dynamic concept. It is Returns: It is a unilateral payment for which no services
measured over a period of time. Eg. Consumption, income, are rendered. Usually It is paid by the government.
change in inventory. Eg.Old age pension, Scholarship,Widow pension etc.

Stocks Flows Net Factor Income From Abroad(NFIA): It is the


Supply of money National income difference between the factor income earned by the
Bank deposit Capital formation domestic factors of production employed in the rest of
Food grain stock Foreign remittances the world and the factor income earned by factors of
Foreign currency reserves Imports production of the rest of the world employed in the
Total borrowings Exports domestic country.
Capital Borrowings
Macro Economic Model: Functioning of an imaginary
economy is called Macro Economic Model.
Inventory: The quantity of output that a firm could not be
sold is called Inventory. In short, it is the unsold stock. Circular Flow Of Income In a Two Sector Economy.
Inventory is a stock variable. It may accumulate or de
It is a flow which shows how income of an economy
cumulate.
circulate through different sectors in an economy. The two
Accumulation Of Inventory: If the value of Inventory at the sectors exist in an economy are Firms and Households.
end of year is more than the value of inventory at the Firms are the Production units and they receive factors of
beginning of the year, it is called accumulation of production(factor services) from the households and give
Inventory. rewards for the factors production. The households spent
the entire income received from the firms and nothing to
Decumulation Of Inventory: If the value of Inventory at the save. This is shown by the flow chart.
end of year is less than the value of inventory at the
beginning of the year, it is called decumulation of
Inventory.

Planned Accumulation Of Inventory: The deliberate


increase in the stock of goods of a firm is called Planned
Accumulation of Inventories.

Planned Decumulation Of Inventory: The deliberate


decrease in the stock of goods of a firm is called Planned
decumulation of Inventories.

Unplanned Accumulation Of Inventory: The unexpected


increase in the stock of goods due to the fall in sales is
called Un planned accumulation of Inventories.
In the above diagram the lower most arrow from
Unplanned De Cumulation Of Inventory: The unexpected the household to firms shows the flow of factor services
decrease in the stock of goods due to the rise in sales is such as Land, Labour, Capital and Entrepreneurship from
called Unplanned de cumulation of Inventories. the household to firms. The flow just above the factor
➔ Change in inventory = Closing stock - Opening service flow is the counter flow of factor service flow. The
stock. firms produce goods and services and it flows into the
households. It’s counter flow is spending. The flow of factor
➔ The change of inventories of a firm during a year ≡ services and goods and services is called real flow. And the
production of the firm during the year – sale of the flow of factor rewards and spending is called money flow.
firm during the year.
Measurement of National Income
➔ change of inventories of a firm during a year ≡
value added + intermediate goods used by the firm – The concept of National Income occupies an
sale of the firm during a year. important role in Macro Economics. National Income is the

Dileepkumar Puthiyatath & Sreejith Ponnambath, EKNS GHSS Vengad


sum total of the money value of all final goods and services Expenditure Method :
produced in a country during a financial year plus net
factor income from abroad (NFIA). Various methods for Under this method GDP is calculated by adding
measuring National Income are the following. the final expenditures received by all the firms in the
economy. All the final expenditures are classified into four
1. Product Method or Value Added Method. categories:

2. Income Method. 1-The final consumption expenditure (Ci):

3. Expenditure Method. It is the final consumption expenditure on goods and


services produced by the firms from the households.
Product Method or Value Added Method
2-The final investment expenditure (Ii):
Under this method National Income can be
measured by adding money value of all the final goods and It is the final investment expenditure incurred by other
services produced by each firms in the economy during a firms on capital goods produced by firms.
financial year. Then the problem of Double Counting
arises. Double Counting means value of a good or service is 3-The govt. final consumption expenditure (Gi):
added more than once in the calculation of National Income . It is the expenditure on goods and services produced by
To avoid double counting we use Value Added Method. firms.
Value added or Gross Value Added is difference between
value of output and intermediate Consumption. 4-Net export expenditure (Xi-Mi):

Value Added OR Gross value added = Value of output – It is the difference between the value of Export minus
Value of intermediate Consumption import.

Value of output = market price × quantity of output The sum of all these expenditures are the total income
earned by all firms in the economy. Therefore.
Under value added method we calculate NI by
adding GVA of all firms in the economy during a financial n n n n n

year. We assume that there are N firms in an economy. The GDP= ∑ Ci +∑ Ii+∑ Gi +∑ Xi-∑ Mi
i=1 i=1 i=1 i=1 i=1
NI can be written as follows.
or GDP=C+I+G+X-M
GDP ≡ GVA1 + GVA2 + · · · + GVAN
n
National Income (NNPFC)=GDP+NFIA-Depreciation-NIT
Therefore, GDP= ∑ GVAi Conclusion
i=1
We used three different methods to calculate GDP
NVAi = GVAi – Di here Di= depreciation. or NI. Whatever be the method, we get identical results
There fore, because the value we get through production is the value of
factor rewards such as Rent,Wages and salaries, Interest
National Income (NNPFC)=GDP+NFIA-Depreciation - NIT. and Profit. These income is spent for different
expenditures.
Income Method
National income concepts (Macro Economic Identities/
Under this method NI is calculated by adding all
aggregates)
the factor income received by owners of factors of
production. Income received by land is called Important Macro Economic concepts are.
Rent(Ri),Income received by labour is called Wages and
salaries (Wi),Income received by Capital is called ➔ Personal Income (PI): It is the part of National
Interest(Ini) and Income received by entrepreneurship is Income received by each household of a Country is
called Gross Profit(Pi).Here depreciation charges and Net called Personal Income. It can be written as
Indirect Taxes are included in Gross Profit. Thus GDP can follows.
be written as follows. Personal Income (PI) :≡ NI – Undistributed profits –
n n n n Net interest payments made by households –
GDP= ∑ Wi +∑ Ri +∑ Ini +∑ Pi or Corporate tax + Transfer payments made to the
i=1 i=1 i=1 i=1 households from the government and firms.
GDP=W+R+In+P
➔ Personal Disposable Income(PDI): If we deduct the
There Fore, Personal Tax Payments(income tax, for example)
and Nontax Payments (such as fines) from PI, we
National Income (NNPFC)=GDP+NFIA-Depreciation-NIT. obtain what is known as the Personal Disposable
Income. Thus

Dileepkumar Puthiyatath & Sreejith Ponnambath, EKNS GHSS Vengad


PDI ≡ PI – Personal tax payments – Non-tax payments. ➔ Net National Product (NNP): NNP is the total
money value of all final goods and services
➔ Per Capita Income (PCI): PCI is the annual produced by the country in an Economic year less
average per head Income of the people of a Depreciation. It can be written as follows.
Country.
NNP ≡ GNP- Depreciation
PCI=National income/Population
➔ NNPFC (National Income):
➔ National Disposable Income (NDI): It is the
Income from all sources available to the residents NNP at factor cost is the sum of income earned by
of a Country for consumption expenditure and all factors in the production in the form of wages,
Savings for one year. profits, rent and interest, etc., belonging to a
country during a year.
NDI ≡ NNPMP+ Other current transfers from the rest of the
world. NI = NNP MP − Net Product Taxes - Net
ProductionTaxes
➔ Private Income:
NI= NDP FC + NFIA = NNP FC
Private Income = Factor income from net domestic
product accruing to the private sector + National ➔ GVA at Market Prices =GDP at market prices
debt interest + Net factor income from abroad +
Current transfers from government + Other net ➔ GVA at basic prices = GVAMP - Net Product Taxes
transfers from the rest of the world. Net Product Tax is equal to product taxes less
➔ GDP Market Price (GDPmp):GDP is the total product subsidies)
money value of all final goods and services Eg:GST, Excise Tax, Service Tax, Import Export
produced in the domestic territory of a Country in duties
a year. The value of GDP calculated on the basis
price prevail in the market is called GDPmp. It ➔ GVA at factor cost =GVA at basic prices - Net
includes Indirect Tax and don’t include Subsidies. Production Taxes

NDPmp ≡ GNPmp –Depreciation. Net Production Tax is equal to production taxes


GDPmp ≡NDPmp+Depreciation less production subsidies

➔ GDP Factor Cost (GDPFC): It is the difference Eg: Stamp duty, Registration fee etc.
between GDPMP and Net Indirect Tax
GDP and Prices: GDP is affected by changes in
GDPFC≡GDPMP-NIT GDP FC price level. An increase in price level, results an
≡NDPFC+Depreciation increase in the value of GDP and vice versa. To
eliminate the of change in price level, Economists
➔ Net Domestic Product (NDP): NDP is the total calculate Nominal and Real GDP.
money value of all final goods and services
produced in the domestic territory of a Country Nominal GDP: The value of GDP calculated on the
less Depreciation. basis of current year prices is called Nominal GDP.
It is denoted with ‘GDP'.
NDP ≡ GDP- Depreciation
Real gdp: The value of GDP calculated on the basis
➔ NDP at factor cost: NDP at factor cost is the for base year prices is called Real GDP. It is
income earned by the factors in the form of wages, denoted with ‘gdp'.
profits, rent, interest, etc., within the domestic
territory of a country. GDP Deflator: It is the ratio between nominal GDP
and Real gdp. It can be written as follows
➔ NDP FC = NDP MP - Net Product Taxes - Net
ProductionTaxes 𝐺𝐷𝑃 𝑑𝑒𝑓𝑙𝑎𝑡𝑜𝑟=𝐺𝐷𝑃/𝑔𝑑𝑝 or 𝐺𝐷𝑃/𝑔𝑑𝑝×100

➔ Gross National Product (GNP): GNP is defined as Consumer Price Index (CPI): This is the index of prices of
the sum of GDP and Net Factor Income from a given basket of commodities which are bought by the
abroad. It can be written as follows. representative consumer.CPI is generally expressed in
percentage terms. We have two years under consideration –
GNP ≡ GDP+ NFIA one is the base year, the other is the current year. The
➔ GNP at factor cost measures value of output following are the main differences between GDP deflator
received by the factors of production belonging to and CPI
a country in ayear.

GNP FC =GNP MP -Net Product Taxes - Net


ProductionTaxes

Dileepkumar Puthiyatath & Sreejith Ponnambath, EKNS GHSS Vengad


GDP Deflator Consumer Price Index Medium of exchange: The most important function
Does not include prices Include prices of imported of money is that it serves as a medium of exchange.
of imported goods goods In the barter economy commodities were
Weights differ The weights are constant exchanged for commodities. But it had experienced
according to production many difficulties with regard to the exchange of
level of each good goods and services.

Takes all consumers Takes representatives only  Measure of value : Another important function of
money is that the money serves as a common
Whole Sale Price Index (WPI):It measures the relative measure of value or a unit of account. Under
changes in Whole sale prices. It is also called Producers barter system there was no common measure of
Price Index. value and the value of different goods were
measured and compared with each other.
Why GDP is not considered as a good indicator of welfare?
 Store of value : Money acts as a store of value.
There are at least three reasons why GDP is not considered
Money being the most liquid of all assets is a
as a good indicator of welfare. They are the following.
convenient form in which to store wealth. Thus
1. Distribution of GDP – how uniform is it: If the GDP of money is used to store wealth without causing
the country is rising,the welfare may not rise as a deterioration.
consequence. This is because the rise in GDP may be
 Standard of deferred payments : Another
concentrated in the hands of very few individuals or firms.
important function of money is that it serves as a
2. Non-monetary exchanges: Many activities in an economy standard for deferred payments. Deferred
are not evaluated in monetary terms. For example, the payments are those payments which are to be
domestic services women perform at home are not paid for. made in future. If a loan is taken today, it would be
paid back after a period of time.
3. Externalities: It refers to the benefits (or harms) a firm
or an individual causes to another for which they are not  Transfer of value: Money helps to transfer value
paid (or penalised).Externalities do not have any market in from one place to another.
which they can be bought and sold.
Demand for money
4. Harmful goods: The production of harmful goods like
The desire of a person to hold money in hand is
tobacco, alcohol etc. are included in GDP. But we cannot
simply called demand for money or liquidity preference.
say that will increase welfare.
Demand for money arise because money is the most liquid
Chapter-3 and generally accepted medium of exchange. According to
J.M Keynes the demand for money is the sum of the money
Money and Banking required for three motives.
Barter system:It is a system of exchange in which one good  1-Transaction Motive
is exchanged for other.
 2-Speculative Motive
Limitations of Barter system
 3-Precaution Motive
➢ Absence of double coincidence of wants
Transaction Motive:
➢ Absence of common measure of value
People hold Money in hand for meeting their day
➢ Lack of store of value to day expenses is called Transaction Motive. Transaction
motive depends on the volume of transactions. When the
➢ Lack of standard of deferred payment
volume of transaction increases, Transaction Demand for
➢ Problem of indivisibility. Money also increases. Transaction Demand For Money is a
fraction of the volume of transactions in the economy over
Money-Definition a period of time. It can be written as follows.
According to Robertson, "Money can be defined as M d T = k.T
anything which is commonly accepted in exchange
for goods and services and discharging other kinds Here, MdT = Transaction demand for money.
of obligations."
T = Total volume of transaction
According to W.A.Walker, "Money is what money
k = A positive fraction.
does."
In other words k is the inverse of velocity of
Functions of Money : The major functions of money are:
circulation of money(v). Velocity of money is the number of

Dileepkumar Puthiyatath & Sreejith Ponnambath, EKNS GHSS Vengad


times a unit of money changes hands during a period of In the diagram when r decreases from r max to r
time. It can be written as follows. min The value of Msd increases from 0 to ∞. When the
interest rate is very high (r max) everyone expects it to fall
MdT = kT , 1/k MdT = T , VMdT = T in the future, and the price of bonds to go up. Hence people
(since V=1/k) convert money into bonds to get capital gain from bonds.
ie. Md T = T/V Thus speculative demand for money is low at high rate of
interest.
In a real Economy Transaction Demand For
Money depends on the volume of GDP. If GDP increases, When interest rate comes down, people expect
Transaction Demand For Money also increases. Then the interest rate to rise and price of bonds to fall in the future.
equation can be written as follows. Thus they convert their bonds into money to avoid capital
loss. This causes high speculative demand for money.
Md T = kPY , Hence speculative demand for money is inversely related to
the rate of interest.
here, k = positive fraction, P = Price level, Y = Real GDP
Precautionary Motive
Speculative Motive:
It is the money held for meeting unexpected
The desire of people to hold money in their hands
expenditure like accident, illness etc in the future.
for speculative purpose (or gain from bonds) is called
Here money is held as a safety stock.
speculative motive.
The supply of Money
Here bonds mean any assets like gold, land,
securities, shares etc. Money supply refers to the total amount of money
available in the economy. It consists of currency notes and
The relationship between market rate of interest
coins issued by the monetary authority and demand and
and price of bond is inverse. ie, when the market rate of
time deposits created by commercial banks.
interest is high the bond price will be less and vice versa
The total volume of money in circulation and
Suppose the market rate of interest is high, then
which can be spent by the people at a specific point of time
the price of the bond will be low. Expecting a fall in Market
in an economy is money supply.
rate of interest in future, people will invest in bonds now to
make profit in future. Then the Speculative Demand For The cash balance in government treasuries, Central Banks
Money will be low here. On the other hand suppose the and the cash reserves of commercial banks held by the RBI
market rate of interest is very low, expecting a rise in do not come under Money Supply.
Market rate of interest in future, people will keep Money
with them. Here Speculative Demand For Money will be Money supply is a stock variable.
infinity. Such a situation is known as liquidity trap. Fiat money:It is the money backed by the order of the
government (fiat) to act as money.
Liquidity Trap: It is a situation in which speculative
demand for money is perfectly elastic where the rate of Currency notes and coins are used as money because they
interest reaches the lowest level. have general acceptability and the legal backing of the govt.

Speculative demand for money can be written as follows. As they circulate because of the order of the govt. they are
called fiat money.

They are also called legal tender money because of the legal
backing of the monetary authority.

Intrinsic Value of money:It is the actual value or material


value of money. Gold coin and silver coin have intrinsic
Here, r max & r min = maximum &minimum rate of
value, equal to its face value.
interest,
Measures of Money Supply
r = current rate of interest.
RBI publishes four alternative measures of money-
It can be shown diagrammatically as follows.
M1,M2,M3 &M4.

M1 = CU + DD

M2 = M1 + Savings deposits with Post Office savings banks

M3 = M1 + Net time deposits of commercial banks

M4 = M3 + Total deposits with Post Office savings


organisations (excluding National Savings Certificates)

Dileepkumar Puthiyatath & Sreejith Ponnambath, EKNS GHSS Vengad


where, CU is currency (notes plus coins) held by the We can understand this by taking example of an
public, DD is net demand deposits held by commercial economy with one bank. Let us assume that our bank starts
banks. with a deposit of Rs 100. The reserve ratio is 20%. Thus
our bank has Rs 80 (100 – 20) to lend and the bank lends
M1 and M2 are known as narrow money. out Rs 80 to Person A, which shows up in the bank’s
M3 and M4 are known as broad money. deposits in the next round as liabilities, making a total of Rs
180 (100+80) as deposits. Now our bank is required to keep
These measures are in decreasing order of 20% of 180 i.e. Rs 36 as cash reserves. Recall that our bank
liquidity. M1 is most liquid and easiest for transactions had started with Rs 100 as cash. Since it is required to keep
whereas M4 is least liquid of all.M3 is the most commonly only Rs 36 as reserves, it can lend Rs 64 again (100 – 36 =
used measure of money supply. It is also known as 64).The bank lends out Rs 64 to Person B. This in turn
aggregate monetary resources. shows up in the bank as deposits. The process keeps
repeating itself till all the required reserves become Rs 100.
Central bank
The required reserves will be Rs 100 only when the total
The central bank is the highest authority in a deposits become Rs 500. This is because for deposits of Rs
country`s monetary system. India`s central bank is the 500, cash reserves would have to be Rs 100 (20 per cent of
Reserve Bank of India (RBI). Which came into existence in 500 = 100).
1935.

Functions of Central Bank

 Issue of currency: It has the monopoly power of


printing and issuing currency notes except coins
and one rupee note.

 Banker`s bank: Central bank control all other


commercial banks and financial institution of a
country and also give assistance and guide lines.

 Banker to the government: It perform all the


banking business of the government. it also advice
the government on monetary matters.

 Controller of money supply: The central bank


control the total size of the money supply of an
economy.

 Custodian of Foreign Exchange: The central Bank


is the custodian of the foreign Exchange reserves of
a nation.

 Lender of Last Resort: Central bank extend its It is clear from this example that an initial deposit
helps to Commercial Banks in the time of financial of Rs 100 in the bank becomes a deposit of Rs 500. That is
difficulties. we can see five times increase in deposit with the bank. This
Commercial Bank is also known as money multiplier.

Commercial banks are those institutions that Money Multiplier


accept deposit from the public and give loans to those who An initial increase in money supply(High powered
are in need of it. Money) in the economy causes multiples of increase in
Spread: Spread is the difference between deposit rate and money supply in the economy. This is called money
lending rate. Spread is the profit appropriated by a multiplier.
commercial bank. 1
Money Multiplier=
Money Creation or Credit Creation by banking system. CRR

When a bank lend, a particular amount of money In an example of initial deposit of Rs 100 and CRR-
to a person, a new deposit is opened with the same amount 20% .Money
in that bank in the name of the borrower. Thus money
supply increases (old deposits plus new deposit). This
1
Multiplier= =5
feature of commercial banks is known as credit creation by 0.2
banks. This is an important factor determining the total
This means that total increase in money supply is
money supply in an economy.
5x100=500.

Dileepkumar Puthiyatath & Sreejith Ponnambath, EKNS GHSS Vengad


Policy Tools To Control Money Supply (Instruments of release of the security. This is repurchase agreement or
Monetary Policy) REPO. Here interest rate is repo rate.

Policies undertaken by the central bank of a ➢ Some times central bank may sell securities
country, to control the money supply is called monetary through an agreement which has a specification
policy. Monetary policy aim at controlling of money supply. about the date and price at which it will be
During inflation money supply was high and then central repurchased. This is Reverse Repo .
bank reduces money supply. During deflation money
supply has to be reduced. ➢ During inflation the central bank raises the repo
rate to reduce money supply. During deflation the
The RBI uses quantitative and qualitative tools for central bank reduces repo rate.
controlling money supply.
B. In qualitative measures the central bank uses its moral
A. Central bank uses the following quantitative tools to authority to persuade banks to act in a particular way.
control money supply. Which is done through moral suasion, margin
requirement etc.
1- Reserve Ratios (CRR and SLR)
Demonetisation
2-Bank Rate
Demonetisation was a new initiative taken by
3-Open Market Operations government of India on 8th November 2016. As per this old
1.Reserve Ratios (CRR and SLR) currency notes of Rs 500 and Rs1000 were withdrawn,
because these currency notes have no longer legal tender.
Cash Reserve Ratio (CRR) is the Percentage of deposits
which a bank must keep as cash reserves with the bank. Objectives of Demonetisation

Banks are also required to keep some reserves in liquid • Tackle the problems of Corruption , Black Money,
form in the short term(in the form of government securities Terrorism and
or such liquid assets). This ratio is called Statutory • Circulation of fake currencies in the economy.
Liquidity Ratio or SLR.
Problems in connection with Demonetisation (Criticisms)
During inflation both CRR and SLR will increase
and there by control inflation by reducing money supply. • Long queues outside Banks and ATMs created
During deflation SLR and CRR should increase. difficulties in Normal life.

2. Bank Rate • Shortage of Currency in Circulation had an


adverse impact on the economic activities.
It is the rate at which RBI lends money to
commercial banks when they need money or it is the rate of • Could not achieve its targets as it hoped.
interest paid by commercial banks on short term loans
from RBI . Positive Effects of Demonetisation (Appreciations )

During inflation RBI increase bank rate lead to • It improved tax compliance as a large number of
increase rate of interest and reduce credit creation and people were bought in the tax ambit.
money supply. During deflation RBI reduce bank rate. • The savings of an individual were channelised into
3.Open Market Operation : the formal financial system.

Open market operations are another quantitative • banks have more resources at their disposal which
method of credit control. This method refers to the sale and can be used to provide more loans at lower interest
purchase of securities, bills and bonds of government and rates.
private financial institutions by the central bank from the • Tax evasion will no longer be tolerated and will
open market. During the inflation time RBI Sells securities result in financial penalty and social
and the time of deflation RBI purchase securities. condemnation.
There are two types of open market operations: outright • Households and firms have begun to shift from
and repo: cash to electronic payment technologies.
Outright open market operations:When the central bank *********************
buys or sells securities without any promise to sell or buy
them later is called Outright open market operations.
Outright open market operations are permanent in nature.

Repo: The central bank buys the security (lends to


commercial banks) by specifying the date and price of

Dileepkumar Puthiyatath & Sreejith Ponnambath, EKNS GHSS Vengad

You might also like