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SEMESTER-III,
S.Y.B.M.S

CENTRAL BANKING

GUIDE: PROF. VIJAY

KAPOOR
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GROUP MEMBERS
SR ROLL NAME SIGN
NO. NO
1. 56 RAFIYA
CHALLANGAYAM
2. 60 SAUDAH KHATRI
3. 63 MASOOM SHELIA

SR NO. TOPIC PAGE NO.

1. INTRODUCTION 5
2. DEFINITION 5
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3. HISTORY 6
4. NEED OF CENTRAL BANKS 6
5. OBJECTIVES 7
6. FUNCTIONS 7
7. REDISCOUNTING & 8
LENDER OF LAST RESORT
8. CENTRAL BANKS BY 8
COUNTRIES
9. INFLUENCES 9
10. ACTIVITIES 11
11. RESERVE BANK OF INDIA 12
12. PREAMBLE OF RBI 12
13. HISTORY 12
14. FUNCTIONS 14
15. RESERVE BANK OF INDIA 16
ACT(1935)
16. CREDIT CREATION 17
17. MONETARY POLICY 18
18. TYPES 21
19. CONCLUSION 22
20. CONTRIBUTION 23
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ACKNOWLEDGEMENT

We would like to thank, our Professor Mr.

Vijay kapoor for giving us an opportunity
to take the topic “central banking” for
our project.
He has truly explained us the topic in a
very wide sense by explaining all the
aspects which are a part of central
banking
He has also acted as our guide and
mentor in giving us all the possible
details and important points which were
necessary in making this project
successful

CENTRAL BANKING
INTRODUCTION
A central bank, reserve bank, or monetary authority is a banking institution granted
the exclusive privilege to lend a government its currency. Like a normal commercial
bank, a central bank charges interest on the loans made to borrowers, primarily the
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government of whichever country the bank exists for, and to other commercial banks,
typically as a 'lender of last resort'. However, a central bank is distinguished from a
normal commercial bank because it has a monopoly on creating the currency of that
nation, which is loaned to the government in the form of legal tender. It is a bank that
can lend money to other banks in times of need. Its primary function is to provide the
nation's money supply, but more active duties include controlling subsidized-loan
interest rates, and acting as a lender of last resort to the banking sector during times of
financial crisis (private banks often being integral to the national financial system). It
may also have supervisory powers, to ensure that banks and other financial
institutions do not behave recklessly or fraudulently.
Most of the rich countries today have an "independent" central bank, that is, one
which operates under rules designed to prevent political interference. Examples
include the European Central Bank (ECB) and the Federal Reserve System in the
United States. Some central banks are publicly owned, and others are privately
owned. For example, the United States Federal Reserve is a quasi-public corporation.

DEFINITION OF CENTRAL BANKING

The central bank has been described as "the lender of last resort", which means that it
is responsible for providing its economy with funds when commercial banks cannot
cover a supply shortage. In other words, the central bank prevents the country's
banking system from failing. However, the primary goal of central banks is to provide
their countries' currencies with price stability by controlling inflation. A central bank
also acts as the regulatory authority of a country's monetary policy and is the sole
provider and printer of notes and coins in circulation. Time has proved that the central
bank can best function in these capacities by remaining independent from government
fiscal policy and therefore uninfluenced by the political concerns of any regime. The
central bank should also be completely divested of any commercial banking interests.

THE HISTORICAL ANTECEDENTS OF

CENTRAL BANK IN INDIA
In India, the efforts to establish a banking institution with central banking character
dates back to the late 18th century. The Governor of Bengal in British India
recommended the establishment of a General Bank in Bengal and Bihar. The Bank
was set up in 1773 but it was short-lived. It was in the early 20th century that,
consequent to the recommendations of the Chamberlain Commission (1914)
proposing the amalgamation of the three Presidency Banks, the Imperial Bank of
India was formed in 1921 to additionally carry out the functions of central banking
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along with commercial banking. In 1926, the Royal Commission on Indian Currency
and Finance (Hilton Young Commission) recommended that the dichotomy of
functions and divisions of responsibilities for control of currency and credit should be
ended. The Commission suggested the establishment of a central bank to be called the
Reserve Bank of India, whose separate existence was considered necessary for
augmenting banking facilities throughout the country. The Bill to establish the RBI
was introduced in January 1927 in the Legislative Assembly, but it was dropped due
to differences in views regarding ownership, constitution and composition of its
Board of Directors. Finally, a fresh Bill was introduced in 1933 and passed in 1934.
The RBI Act came into force on January 1, 1935. The RBI was inaugurated on April
1, 1935 as a shareholders’ institution and the Act provided for the appointment by the
Central Government of the Governor and two Deputy Governors. The RBI was
nationalized on January 1, 1949 in terms of the Reserve Bank of India (Transfer to
Public Ownership) Act, 1948 (RBI, 2005b).

NEED FOR CENTRAL BANKING

- to regulate the activities of commercial banks
- to integrate the activities of commercial banks
- to direct the policies according to the best interest of the national banking
- to stabilize the monetary and banking system of the country
- to implement monetary policy to regulate and control credit
- to maintain the external value of the country’s currency in terms of key
foreign currencies such as Dollars, Euros , Pounds etc
- to maintain the country’s international liquidity position at a safe margin
- to exercise a reasonable control over foreign exchange
- to secure the advantages of centralised cash reserves

OBJECTIVES OF CENTRAL BANK

- To help ensure the monetary stability of the country.

- To assist in regulating the financial system of the country
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- To formulate, implement and monitor the monetary policy.

- To maintain the liquidity in the country.
- To ensure adequate flow of credits.
- Prescribes parameters for banking in the country.
- Maintain public confidence in the system.
- To manage the foreign exchange Management Act.
- To facilitate external trade.
- Issue and exchange currency.
- Maintain supply of currency.
- Own and operate the depository and exchange for government bonds.
- Banker to the government

FUNCTIONS OF CENTRAL BANKS

1-Sole right of note issue
The Central Bank in every country, now, has the monopoly note issue. The issue of
notes is governed by certain regulation which is enforced by the state.

2-Banker to the state

A Central Bank acts as a banker to the government. It holds cash balances of the
government free of interest.

3- Banker's bank.
The central bank acts as a banker to the commercial banks.

The Central Bank acts as a clearing house for the settlement of mutual obligations of
different commercial banks. If a difference exists, it is paid by a cheque drawn on the
banks accounts carried at the Central Bank.

5-Lendor to the last resort

The Central Bank helps the member banks in times of crisis.

6-Financial agent
The Central Banks act as financial agents for the government. It is an agent for the
government in purchasing and selling of gold and foreign exchange.

7-Effective monetary policy

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The aim of the government is to create employment in the country, resist undue
inflation and achieve a favorable balance of payment.

CENTRAL BANK AS THE BANK OF

REDISCOUNT AND THE LENDER OF
LAST RESORT
The function of rediscount and lender of last resort developed out of the
special position of the bank which was granted the complete residual
monopoly of note issue in the country and whose notes enjoyed the privilege
of being legal tender.
The function of lender of last resort was historically associated with that
rediscount, since it was through the lack of the latter function that the former
came to be fulfilled. The rediscount function however preceded that of
lender of last resort, while in many countries it has remained the custom for
the central bank to rediscount for individual banks as a matter of
convenience to them , at any time ,and not only when they had exhausted all
other available sources and methods for the replenishment of their funds.

CENTRAL BANKS BY COUNTRIES-

List of central banks
1) Australia- Reserve bank of Australia
2) Bahrain-Central bank of Bahrain
3) Canada-Bank of Canada
4) Dominican Republic- Central Bank of Dominican Republic
5) Egypt- Central bank of Egypt
6) France-Bank of France
7) Guyana- Bank of Guyana
8) Hong Kong Monetary Authority
9) India- Reserve Bank of India
10) Japan- Bank of Japan
11) Kyrgyzstan- National Bank of Kyrgyz Republic
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12) Libya – Bank of Libya

13) Malaysia- Bank Negara Malaysia
14) Nepal- Central Bank of Nepal
15) Oman – Central Bank of Oman
16) Pakistan- State Bank of Pakistan
17) Qatar- Qatar Central bank
18) Russia- Central Bank of Russian Federation
19) Serbia- Central Bank of Serbia
20) Thailand-Bank of Thailand
21) Uganda- Bank of Uganda
22) Vietnam – State Bank of Vietnam
23) West African Economic and Monetary Union – Central Bank of West African
States.
24) Yemen- Central bank of Yemen

HOW THE BANK INFLUENCES AN

ECONOMY

A central bank can be said to have two main kinds of functions:

(1) Macroeconomic when regulating inflation and price stability

(2) Microeconomic when functioning as a lender of last resort .

MACRO-ECONOMICS INFLUENCES

As it is responsible for price stability, the central bank must regulate the level of
inflation by controlling money supplies by means of monetary policy. The central
bank performs open market transaction that either injects the market with liquidity or
absorbs extra funds, directly affecting the level of inflation. To increase the amount of
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money in circulation and decrease the interest rate (cost) for borrowing, the central
bank can buy government bonds, bills, or other government-issued notes. This buying
can, however, also lead to higher inflation. When it needs to absorb money to reduce
inflation, the central bank will sell government bonds on the open market, which
increases the interest rate and discourages borrowing. Open market operations are the
key means by which a central bank controls inflation, money supply, and price
stability.

MICRO-ECONOMICS INFLUENCES

The establishment of central banks as lender of last resort has pushed the need for
their freedom from commercial banking. A commercial bank offers funds to clients
on a first come, first serve basis. If the commercial bank does not have enough
liquidity to meet its clients' demands (commercial banks typically do not hold
reserves equal to the needs of the entire market), the commercial bank can turn to the
central bank to borrow additional funds. This provides the system with stability in an
objective way; central banks cannot favor any particular commercial bank. As such,
many central banks will hold commercial-bank reserves that are based on a ratio of
each commercial bank's deposits. Thus, a central bank may require all commercial
banks to keep, for example, a 1:10 reserve/deposit ratio. Enforcing a policy of
commercial bank reserves functions as another means to control money supply in the
market. Not all central banks, however, require commercial banks to deposit reserves.
The United Kingdom, for example, does not have this policy while the United States
does.

The rate at which commercial banks and other lending facilities can borrow short-
term funds from the central bank is called the discount rate (which is set by the central
bank and provides a base rate for interest rates). It has been argued that, for open
market transactions to become more efficient, the discount rate should keep the banks
from perpetual borrowing, which would disrupt the market's money supply and the
central bank's monetary policy. By borrowing too much, the commercial bank will be
circulating more money in the system. Use of the discount rate can be restricted by
making it unattractive when used repeatedly.

TRANSITIONAL ECONOMIES
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Today developing economies are faced with issues such as the transition from
managed to free market economies. The main concern is often controlling inflation.
This can lead to the creation of an independent central bank but can take some time,
given that many developing nations maintain control over their economies in an effort
to retain control of their power. But government intervention, whether direct or
indirect through fiscal policy, can stunt central bank development. Unfortunately,
many developing nations are faced with civil disorder or war, which can force a
government to divert funds away from the development of the economy as a whole.
Nonetheless, one factor that seems to be confirmed is that, for a market economy to
develop, a stable currency (whether achieved through a fixed or floating exchange
rate) is needed. However, the central banks in both industrial and emerging
economies are dynamic because there is no guaranteed way to run an economy
regardless of its stage of development.

ACTIVITIES AND RESPONSIBILITIES

Functions of a central bank are:-
• implementing monetary policy
• determining Interest rates
• controlling the nation's entire money supply
• the Government's banker and the bankers' bank ("lender of last resort")
• managing the country's foreign exchange and gold reserves and the
Government's stock register
• regulating and supervising the banking industry
• setting the official interest rate – used to manage both inflation and the
country's exchange rates – and ensuring that this rate takes effect via a variety
of policy mechanism

RESERVE BANK OF INDIA

The Reserve Bank of India (RBI, Hindi: भारतीय िरजवर बैक) is the central banking
system of India and controls the monetary policy of the rupee as well as 287.37
billion US-Dollar (2009) currency reserves. The institution was established on 1 April
1935 during the British Raj in accordance with the provisions of the Reserve Bank of
India Act, 1934 and plays an important part in the development strategy of the
government.
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PREAMBLE OF THE RESERVE BANK OF

INDIA
"...to regulate the issue of Bank Notes and keeping of reserves with a view to securing
monetary stability in India and generally to operate the currency and credit system of
the country to its advantage."

The Preamble of the RBI speaks about the basic functions of the bank. It deals with
the issuing the bank notes and keeping reserves in order to secure monetary stability
in the country. It also aims at operating and boosting up the currency and credit
infrastructure of India.

HISTORY

1935 – 1950
The central bank was founded in 1935 to respond to economic troubles after the First
World War. The Reserve Bank of India was set up on the recommendations of the
Hilton Young Commission. The commission submitted its report in the year 1926,
though the bank was not set up for another nine years. The Preamble of the Reserve
Bank of India describes the basic functions of the Reserve Bank as to regulate the
issue of Bank Notes, to keep reserves with a view to securing monetary stability in
India and generally to operate the currency and credit system in the best interests of
the country. The Central Office of the Reserve Bank was initially established in
Kolkata, Bengal, but was permanently moved to Mumbai in 1937. The Reserve Bank
has continued to act as the central bank for Myanmar till Japanese occupation of
Burma and later up to April 1947, though Burma seceded from Indian Union in 1937.
After the partition, the Reserve bank served as the central bank for Pakistan up to
June 1948 when the State Bank of Pakistan commenced operations. Though originally
set up as a shareholder's bank, the RBI has been fully owned by the Government of
India since its nationalization in 1949.

1950 – 1960
Between 1950 and 1960 the Indian government developed a centrally planned
economic policy and focused on the agricultural sector. The administration
nationalized commercial banks and established, based on the Banking Companies
Act, 1949 (later called Banking Regulation Act) a central bank regulation as part of
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the RBI. Beside that the central bank was ordered to support the economic plan with
loans.
1960 - 1969
As a result of bank crashes the reserve bank was requested to establish and monitor a
deposit insurance system. It should restore the trust in the national bank system and
was initialized on 7. December 1961. The Indian government founded funds to
promote the economy and used the slogan Developing Banking. The Gandhi
administration and their successors restructured the national bank market and
nationalized a lot of institutes. As a result the RBI had to play the central part of
control and support of this public banking sector.

1969–1985
Between 1969 and 1980 the Indian government nationalized 20 banks. The regulation
of the economy and especially the financial economic was reinforced by the Gandhi
administration and their successors in the 1970s and 1980s.The central bank became
the central player and increased her policies for a lot of tasks like interests, reserve
ratio and visible deposits. The measures aimed at a better economic development and
had a huge effect on the company policy of the institutes. The banks lent money in
selected sectors like agri-business and small trade companies.
The branch was forced to establish two new offices in the country for every new
founded office in a town. The Oil crisis in 1973 resulted in increasing inflation and
the RBI restricted the monetary policy to reduce the effects.

1985–1991
A lot of committees analyzed the Indian economy between 1985 and 1991. Their
results had an effect on the RBI. The Board for Industrial and Financial
Reconstruction, the Indira Gandhi Institute of Development Research and Security &
Exchange Board of India investigated the national economy as a whole and the
security and exchange board proposed better methods for more effective markets and
the protection of investor interests. The Indian financial market was a leading
example for - so called - "financial repression" (Mackinnon and Shaw). Discount and
Finance House of India began his operations on the monetary market in April 1988,
the National Housing Bank, founded in July 1988, was forced to invest in the property
market and a new financial law improved the versatility of direct deposit by more
security measures and liberalisation.

1991–2000
The national economy came down in July 1991 and the Indian rupee was devalued.
The currency lost 18% related to the Us-Dollar and the Narsimahmam Committee
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adviced to restructure the financial sector by a temporal reduced reserve ratio as well
as the statutory liquidity ratio. New guidelines were published in 1993 to establish a
private banking sector. This turning point should reinforce the market and was often
called neo-liberal .The central bank deregulated the bank interests and some sectors of
the financial market like the trust and the property market. This first phase was a
success and the central government forced a diversity liberalisation to diversify the
owner structures in 1998.
The National Stock Exchange of India took the trade on in June 1994 and the RBI
allowed nationalized banks in July to interact with the capital market to reinforce their
capital base. The central bank founded a subsidiary company - the Bharatiya Reserve
Bank Note Mudran Limited - in February 1995 to produce banknotes.

SINCE 2000
The Foreign Exchange Management Act from 1999 came into force in June 2000. It
should improve the foreign exchange market, international investments in India and
transactions. The RBI promoted the development of the financial market in the last
years, allowed online banking in 2001 and established a new payment system in 2004
- 2005 (National Electronic Fund Transfer).The Security Printing & Minting
Corporation of India Ltd., a merger of nine institutions, was founded in 2006 and
produces banknotes and coins.
The national economy's growth rate came down to 5.8% in the last quarter of 2008 -
2009 and the central bank promotes the economic development.

FUNCTIONS OF RESERVE BANKS

Monetary Authority

The Reserve Bank of India is the main monetary authority of the country and beside
that the central bank acts as the bank of the national and state governments. It
formulates implements and monitors the monetary policy as well as it has to ensure an
adequate flow of credit to productive sectors. Objectives are maintaining price
stability and ensuring adequate flow of credit to productive sectors. The national
economy depends on the public sector and the central bank promotes an expensive
monetary policy to push the private sector since the financial market reforms of the
1990s.

The institution is also the regulator and supervisor of the financial system and
prescribes broad parameters of banking operations within which the country's banking
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and financial system functions. Objectives are to maintain public confidence in the
system, protect depositors' interest and provide cost-effective banking services to the
public. The Banking Ombudsman Scheme has been formulated by the Reserve Bank
of India (RBI) for effective redressal of complaints by bank customers. The RBI
controls the monetary supply, monitors economic indicators like the gross domestic
product and has to decide the design of the rupee banknotes as well as coins,

Manager of exchange control

The central bank manages to reach the goals of the Foreign Exchange Management
Act, 1999. Objective: to facilitate external trade and payment and promote orderly
development and maintenance of foreign exchange market in India.

Issuer of currency

The bank issues and exchanges or destroys currency and coins not fit for circulation.
The Objectives are giving the public adequate supply of currency of good quality and
to provide loans to commercial banks to maintain or improve the GDP. The basic
objectives of RBI are to issue bank notes, to maintain the currency and credit system
of the country to utilize it in its best advantage, and to maintain the reserves. RBI
maintains the economic structure of the country so that it can achieve the objective of
price stability as well as economic development, because both objectives are diverse
in themselves.

Developmental role

The central bank has to perform a wide range of promotional functions to support
national objectives and industries. The RBI faces a lot of inter-sectoral and local
inflation-related problems. Some of these problems are results of the dominant part of
the public sector.

Related functions

The RBI is also a banker to the Government and performs merchant banking function
for the central and the state governments. It also acts as their banker. The National
Housing Bank (NHB) was established in 1988 to promote private real estate
acquisition. The institution maintains banking accounts of all scheduled banks, too.

There is now an international consensus about the need to focus the tasks of a central
bank upon central banking. RBI is far out of touch with such a principle, owing to the
sprawling mandate described above. The recent financial turmoil world-over, has
however, vindicated the Reserve Bank's role in maintaining financial stability in
India.
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RESERVE BANK OF INDIA ACT, 1934.

INCORPORATION, CAPITAL,
MANAGEMENT AND BUSINESS
Establishment and incorporation of Reserve Bank

(1) A bank to be called the Reserve Bank of India shall be constituted for the purposes
of taking over the management of the currency from the Central Government and of
carrying on the business of banking in accordance with the provisions of this Act.

(2) The Bank shall be a body corporate by the name of the Reserve Bank of India,
having perpetual succession and a common seal, and shall by the said name sue and
be sued.

Capital of the Bank

The capital of the bank shall be five crores of rupees.

Management

(1) The Central Government may from time to time give such directions to the Bank
as it may, after consultation with the Governor of the Bank, consider necessary in the
public interests.

(2) Subject to any such directions, the general superintendence and direction of the
affairs and business of the Bank shall be entrusted to a Central Board of Directors
which may exercise all powers and do all acts and things which may be exercised or
done by the Bank.

(3) Save as otherwise provided in regulations made by the Central Board, the
Governor and in his absence the Deputy Governor nominated by him in his behalf,
shall also have powers of general superintendence and direction of the affairs and the
business of the Bank, and may exercise all powers and do all acts and things which
may be exercised or done by the Bank.

Business which the Bank may transact

The Bank shall be authorized to carry on and transact the several kinds of business
hereinafter specified, namely:-
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(1) the accepting of money on deposit without interest from, and the collection of
money for, the Central Government, the State Governments, local authorities, banks
and any other persons;

(2) (a) the purchase, sale and rediscount of bills of exchange and promissory notes,
drawn on and payable in India and arising out of bona fide commercial or trade
transactions bearing two or more good signatures, one of which shall be that of a
scheduled bank or a State co-operative bank or any financial institution, which is
predominantly engaged in the acceptance or discounting of bills of exchange and
promissory notes and which is approved by the Bank in this behalf and maturing-

(i) in the case of bills of exchange and promissory notes arising out of any such
transaction relating to the export of goods from India, within one hundred and eighty
days, and

(ii) in any other case, within ninety days,

from the date of such purchase or rediscount exclusive of days of grace;

(b) the purchase, sale and rediscount of bills of exchange and promissory notes,
drawn and payable in India and bearing two or more good signatures, one of which
shall be that of a scheduled bank or a State co-operative bank or any financial
institution, which is predominantly engaged in the acceptance or discounting of bills
of exchange and promissory notes and which is approved by the Bank in this behalf
and drawn or issued for the purpose of financing agricultural operations or the
marketing of crops, and maturing within fifteen months from the date of such
purchase or rediscount, exclusive of days of grace;

CREDIT CREATION
Money creation is the process by which new money is produced or issued. There are
three ways to create money:

• by manufacturing paper currency or metal coins,

• through fractional reserve banking and lending by the banking system,
• and by government policies such as quantitative easing.

The practices and regulation of production, issue and redemption of money are of
central concern to monetary economics (e.g. money supply, monetarism), and affect
the operation of financial markets and the purchasing power of money.

Central banks measure the money supply, which shows the amount of money in
existence at a given time. An unknown portion of the new money created is indicated
by comparing these measurements on various dates.
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The destruction of currency may occur when coins are scrapped to recover their
precious metal content, which can be motivated by the value of the metal coming to
exceed the face value of the coin, or when the issuer redeems the securities.

MONETARY POLICY
Monetary policy is the process by which the central bank or monetary authority of a
country controls the supply of money, often targeting a rate of interest. Monetary
policy is usually used to attain a set of objectives oriented towards the growth and
stability of the economy. These goals usually include stable prices and low
unemployment. Monetary Theory provides insight into how to craft optimal monetary
policy.
Monetary policy is referred to as either being an expansionary policy, or a
contractionary policy, where an expansionary policy increases the total supply of
money in the economy rapidly, and a contractionary policy decreases the total money
supply or increases it only slowly. Expansionary policy is traditionally used to combat
unemployment in a recession by lowering interest rates, while contractionary policy
involves raising interest rates to combat inflation. Monetary policy is contrasted with
fiscal policy, which refers to government borrowing, spending and taxation.

EFFECTIVE MONETARY POLICY

Compared to fiscal policy, monetary policy operates much more indirectly on the
economy. Whereas an expansive fiscal policy puts more money right into the hands of
consumers and businesses, monetary policy affects spending by altering interest rates,
credit conditions, exchange rates, and the asset prices. In the early years of the
Keynesian revolution, some macroeconomists were skeptical about the effectiveness
of monetary policy, just as they were enthusiastic about the newfound tool of fiscal
policy. But over the last two decades the Federal Reserve has adopted a more active
role and shown itself quite capable of slowing or speeding up the economy.

The Federal Reserve is much better placed to conduct stabilization policy than are the
fiscal policy makers. Its staff of professional economists can recognize cyclical
movements as well as anyone. And it can move quickly when the need arises. For
example, on January 28, 1994 the Commerce Department announced that the
economy was growing surprisingly rapidly at year-end 1993; only a week later the
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Federal Reserve moved to slow the expansion by raising interest rates for the first
time in half a decade.

IMPORTANCE OF MONETARY POLICY

The growing importance of monetary policy and the diminishing role played by fiscal
policy in economic stabilization efforts may reflect both political and economic
realities. The experience of the 1960s, 1970s, and 1980s suggests that democratically
elected governments may have more trouble using fiscal policy to fight inflation than
unemployment. Fighting inflation requires government to take unpopular actions like
reducing spending or raising taxes, while traditional fiscal policy solutions to fighting
unemployment tend to be more popular since they require increasing spending or
cutting taxes. Political realities, in short, may favor a bigger role for monetary policy
during times of inflation.

One other reason suggests why fiscal policy may be more suited to fighting
unemployment, while monetary policy may be more effective in fighting inflation.
There is a limit to how much monetary policy can do to help the economy during a
period of severe economic decline, such as the United States encountered during the
1930s. The monetary policy remedy to economic decline is to increase the amount of
money in circulation, thereby cutting interest rates. But once interest rates reach zero,
the Fed can do no more. The United States has not encountered this situation, which
economists call the "liquidity trap," in recent years, but Japan did during the late
1990s. With its economy stagnant and interest rates near zero, many economists
argued that the Japanese government had to resort to more aggressive fiscal policy, if
necessary running up a sizable government deficit to spur renewed spending and
economic growth.

GOALS OF MONETARY POLICY

1) Price Stability- Unanticipated inflation leads to lender losses. Nominal contracts
attempt to account for inflation. Effort successful if monetary policy able to
maintain steady rate of inflation.

2) High Employment- The movement of workers between jobs is referred to as

frictional unemployment. All unemployment beyond frictional unemployment is
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classified as unintended unemployment. Reduction in this area is the target of

macroeconomic policy.

3) Economic Growth- Economic growth is enhanced by investment in

technological advances in production. Encouragement of savings supplies funds
that can be drawn upon for investment.

4) Interest Rate Stability- Volatile interest and exchange rates generate costs to
lenders and borrowers. Unexpected changes that cause damage, making policy
formulation difficult.

5) Financial Market Stability

6) Foreign Exchange Market Stability

CONFLICTS AMONG GOALS

Goals frequently cannot be separated from each other and often conflict. Costs must
therefore be carefully weighed before policy implementation. To make conflict
productive, to turn it into an opportunity for change and progress, Follett advises
against domination, manipulation, or compromise. "Just so far as people think that
the basis of working together is compromise or concession, just so far they do not
understand the first principles of working together. Such people think that when
they have reached an appreciation of the necessity of compromise they have reached
a high plane of social development. But compromise is still on the same plane as
fighting. War will continue - between capital and labour, between nation and nation
- until we relinquish the ideas of compromise and concession.

TYPES OF MONETARY POLICY

In practice, all types of monetary policy involve modifying the amount of base
currency (M0) in circulation. This process of changing the liquidity of base currency
through the open sales and purchases of (government-issued) debt and credit
instruments is called open market operation.

Constant market transactions by the monetary authority modify the supply of

currency and this impacts other market variables such as short term interest rates and
the exchange rate.
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The distinction between the various types of monetary policy lies primarily with the
set of instruments and target variables that are used by the monetary authority to
achieve their goals.

Target Market
Monetary Policy: Long Term Objective:
Variable:
Interest rate on
Inflation Targeting A given rate of change in the CPI
overnight debt
Interest rate on
Price Level Targeting A specific CPI number
overnight debt
The growth in money
Monetary Aggregates A given rate of change in the CPI
supply
The spot price of the
Fixed Exchange Rate The spot price of the currency
currency
Low inflation as measured by the
Gold Standard The spot price of gold
gold price
Usually unemployment + CPI
Mixed Policy Usually interest rates
change

The different types of policy are also called monetary regimes, in parallel to exchange
rate regimes. A fixed exchange rate is also an exchange rate regime; The Gold
standard results in a relatively fixed regime towards the currency of other countries on
the gold standard and a floating regime towards those that are not. Targeting inflation,
the price level or other monetary aggregates implies floating exchange rate unless the
management of the relevant foreign currencies is tracking the exact same variables
(such as a harmonized consumer price index).

CONCLUSION
Central banks are responsible for overseeing the monetary system for a nation (or
group of nations), along with a wide range of other responsibilities, from overseeing
monetary policy to implementing specific goals such as currency stability, low
inflation and full employment. The role of the central bank has grown in importance
over time.
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Contribution
Rafiya Challangayam (56) - She has contributed in
making the hard copy of this project. She has also done a bit of
editing in the hard copy. Topic such as need, objectives and
functions of central banking, central bank by countries,
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rediscounting and lender of last resort, Reserve bank of India,

RBI Act, its preamble and writing of the contribution is done
by her.
Saudah Khatri (60) - She has done her job well in making
the soft copy for the topic. She has also contributed in making
the hard copy for the topic which includes research work of the
topic, editing and formatting of the hard copy. Topic such as
introduction, definition and historical antecedents of central
banks, history of Reserve bank of India and rediscounting and
lender of last resort as well as acknowledgement is done by her.
Masoom Shelia (63) - She has contributed well in the
making of soft copy. She did a well research work for the hard
copy. She has referred to all the books given in bibliography to
make this hard copy meaningful. Topic such as monetary
policy, it influences on the economy, effective monetary policy
and its importance which is a vital part of the topic is done by
her.

Bibliography
WEBSITES
• www.google.com
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• www.yahoo.com
• www.msn.com
REFERENCE BOOKS
1. Banking Theory and Practice by Al Shekhar &
Lakshmi Shekar
2. Central Banking by Decock
3. Central Banking in Developing Countries by
Anand Chandavarkar
4. RBI Publications.