The Financial Framework of India: Monetary Policy of RBI Deconstructed

Part of 3 of 3 - Quantitative Easing as an Instrument of Monetary Policy

 

Ministry of Finance, Delhi

Hello friends. In the last two posts, we've actually been talking about how the Reserve bank of vendor offer that matter. Any of the central banks of the world intervene when the economy is slowing down. Today we are going to talk in terms of what has been described, especially in America as quantitative easing.

Now, this is something which is not defined, but we've done a bit of a research to. Or come to a conclusion as to what quantitative easing means to the people who are in the business of central banks and banking regulation and interest rates. In the last two videos, we've talked about the open market operations, and then we talked in terms of monetizing the deficit, which popularly is called printing of notes.

But today we are going to be talking in terms of quantitative. Which is something which is used more of an exceptional type of a mayor by the central banks and not to be used in routine. It is something which in the Indian scriptures is called the Barrister. So literally the ultimate remedy, which the central banks have to trigger the economy when it is going through a slowdown mode.

It was very popularly used by the US Fed in the year 2000. When the global meltdown relating to the housing and mortgage securities and so on happened, and various brokerages and huge houses, they literally collapsed overnight. Now, how is quantitative easing any different from open market operations? As we learned earlier in open market operations, the central bank put chases.

The government securities normally held by the banks. As a result of which the banks get more money into the coffers, they would therefore lend and boost investment. And moreover, when you are purchasing securities, money is coming into the coffers of the banks. The interest rates would also automatically go down because you're pumping cash and liquidity into.

Now what happens in case of quantitative easing, the central bank traditionally can lower the interest rates. The rates at which the Reserve Bank of India lends to the bank overnight. So, if there is any shortage of cash with the banks overnight lending rate, the repo rate, as it is called that, is what determines how costly the money is, the benchmark rate, and from there emanates everything.

you can keep on lowering the rate, but there comes a limit beyond which you cannot really lower down the rate. So it is here that the quantitative easing as a weapon of monetary policy, as an instrumentality of monetary policy is unleashed by the central banks, or in case of India, the Reserve Bank of India.

So what the Reserve Bank does is purchase. Government securities, all right. That it does so in the open market operations also, but it is not only the traditional government securities. There are other things like corporate papers, like corporate fixed deposits securitization of securities like mortgage and housing-based securities and so on.

The Reserve Bank also takes the opportunity of buying those. So when it buy those back, then what happens is that the entities, the cooperate, the companies, the corporations, the non-banking finance companies, they get their money back. And since they are buying, the prices of those securities may go up at the same time, the yields come further down and the confidence of the market in those securities also.

Now, why did the US Fed really buy those housing securities or the mortgage-backed securities? Even though the asset prices or the underlying asset prices had gone below the market value of the prices. That was really to boost the confidence of the market that if the US Federal Reserve is buying those securities, then there is nothing wrong with the system.

We are going to tide over a choppy. Which has hit the ocean, the economic ocean, but it is not something which is going to lead to a dilute, so therefore, quantitative easing A is much bigger in magnitude than the open market operations. It is generally used in extreme circumstances were lowering of the bank rates by the central banks have not worked, and it is extended beyond the traditional government secur.

Or the Terry Bonds, which the banks hold or the public holds. It goes beyond to corporate paper, corporate debt, and so on. Non-bank finance companies. So quantitative easing friends is the ultimate weapon of injecting liquidity, of boosting confidence, and also going beyond where mere cut in interest rates works.

So, this concludes the final post on the instrumentality of the Reserve Bank of India to tackle a slowdown. We have not yet done it in this past covid scenario, but maybe it is coming in case growth doesn't pick up in case the bank lending doesn't pick up and people are just holding onto cash under their mattresses, so to say.

So have a great day, and if you feel that this little post or the series. Little posts are going to be of any value to you or your friends. Please do not hesitate to comment, share, subscribe. Have a great day.