Unit 3 Money and Banking
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The document discusses various topics related to money and banking including inflation, deflation, types of inflation, effects of inflation, demand-pull inflation, cost-push inflation, methods of controlling inflation, anti-inflationary measures, banks, and central banks. It defines key terms and provides examples and explanations of inflation, deflation, different types of inflation based on speed and inducement, effects of inflation on various economic activities, and methods used by governments to control inflation through monetary and fiscal policies.
Unit 3 Money and Banking
- 1. Money and Banking ENGINEERING ECONOMICS & COST ANALYSIS Money and Banking E.E.C.A - B.K.P 1 B.K.Parrthipan, M.E, M.B.A., Assistant Professor / Mechatronics Engineering, Kamaraj College of Engineering and Technology.
- 2. Inflation • Inflation is an economic condition in which the aggregate prices are always increasing in a country. • The value of money is falling. Inflation is nothing• The value of money is falling. Inflation is nothing but too much of money chasing too few goods. • For example in Zimbabwe the inflationary rate is too high as more than 1000 % and in turn they require bag full of money for a meal. And the value of their currency is very low in the market.
- 3. Inflation • Inflation means not only sustainable rise in the price of the goods and services, but the value of the currency falls in the market and the supply of money in circulation is more.the supply of money in circulation is more. • Deflation is the opposite of inflation. It is a state of disequilibrium in which a contraction of purchasing power tends to cause or is the effect of a decline of the price level.
- 4. Types of Inflation A. On the basis of speed 1. Creeping inflation: the inflationary rate is less than 2% that means prices are increasing gradually. 2. Walking inflation: the inflationary rate of a country is2. Walking inflation: the inflationary rate of a country is around 5% little more than creeping. 3. Running inflation: the rate of growth in prices is more i.e. the inflation is growing at the rate of 10%. 4. Galloping inflation: higher growth rate compared to the earlier stages i.e. the change is around 25%.
- 5. Types of Inflation B. On The Basis Of Inducement 1. Deficit induced: the deficit in the balance of payments of the country or fiscal deficit is the reasons for inflation. The value of the currency is falling due to the above mentioned reasons. 2. Wage induced: due to higher wages and salaries the2. Wage induced: due to higher wages and salaries the money supply in the country increases leading to inflation. 3. Profit induced: higher the profit the organizations earn, they tend to share with their stakeholders which induces the money supply and reduces the value of money.
- 6. Types of Inflation 4.Scarcity induced: the raw material and other input factor scarcity (for example petrol) may induce the price hike in the market. 5.Currency induced: the value of currency fluctuates5.Currency induced: the value of currency fluctuates due to various internal and external forces. 6. Sectoral inflation: a particular sector of a country may be the reason for economic growth or money supply. (for example in India the growth in service sector particularly IT)
- 7. Types of Inflation 7. Foreign trade induced: if the country has unfavorable balance of payments, that means the country’s exports are less than the imports, then we need more of foreign currency to make payments to the exporters ultimately this increases the demand for other currencies in the market.currencies in the market. 8. War time, Post war, Peace time: During war period the government expenditure on various amenities will induce the inflation and the production, availability of the commodities will be low which leads to price hike. To settle down the economy after war or natural calamities the government spending will be more.
- 8. Types of Inflation C. On the basis of extent of coverage: Based on the coverage, economists classify the inflation as Open and repressed;Open and repressed; Comprehensive and sporadic
- 9. Effects of Inflation on Various Economic Activities of the Country • On Producers: Producers will earn more profit due to higher prices. • On debtors and creditors: Creditors will be happy to receive more returns on their lending. On wage and salary earners: Wage holders will• On wage and salary earners: Wage holders will struggle to purchase the goods and services. • On fixed income group: Income is fixed but the value of the currency is falling and prices are increasing therefore it is difficult to manage the normal life. i.e. they are affected.
- 10. Effects of Inflation on Various Economic Activities of the Country • On investors: Investors will receive more returns on their investments. • On farmers: Farmers will suffer. • On social, moral and political effects: Due to• On social, moral and political effects: Due to money supply and higher the cash in hand the social, moral values are declining in the society with political disturbances.
- 11. Demand Pull Inflation • Inflation will result if there is too much spending when compared to output. Aggregate demand is greater than aggregate supply which leads to price hike and inflation.price hike and inflation. • An increase in aggregate demand when the economy is at less than full employment level will result in an increase in both price and output. If the economy is at full employment then the demand will increase which leads to inflation.
- 12. Cost Push Inflation • Inflation is caused by change in the supply side of the economy; it increases cost of production, prices and inflation. Initially increase in costs leads to a chain of wageincrease in costs leads to a chain of wage increases which leads to increase in demand and cost.
- 13. Methods of Controlling Inflation • It is clear that the inflationary situation in the long run is not going to help the economy to grow. Therefore the Government has to take many steps to overcome this problem.many steps to overcome this problem. • The given list of measures was taken through monetary and fiscal policy of our country and is explained in detail in the following chapters.
- 14. Methods of Controlling Inflation 1.Monetary measures : to control inflation are: – Bank rate – Open market operations – Higher reserve ratio– Higher reserve ratio – Consumer credit control – Higher margin requirements
- 15. Methods of Controlling Inflation 2.Fiscal measures: – Regulating to Government expenditure – Taxation – Public borrowing– Public borrowing – Debt management – Over valuation of home currency
- 16. Methods of Controlling Inflation 3.Others: – Wage policy – Price control measures and rationing the essential suppliessupplies – Moral suasion
- 17. Anti Inflationary Measures • The two important tools of macro level economic policy are monetary policy and fiscal policy. • The monetary policy regulates the supply of• The monetary policy regulates the supply of money and availability of credit in the economy. • It deals with both the lending and borrowing rates of interest for commercial banks.
- 18. Anti Inflationary Measures • These two tools are used to control inflation and mitigate its severity. 1. Monetary measures: Since too much money is the fundamental problem in the economy, the central banking authorities use variouscentral banking authorities use various instruments to reduce the money supply and credit. 2. Fiscal measures: By adopting suitable measures in taxation, public expenditure and borrowing, the government can curb inflation.
- 19. Deflation • In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). • Inflation reduces the real value of money over• Inflation reduces the real value of money over time; conversely, deflation increases the real value of money – the currency of a national or regional economy. • This allows one to buy more goods and services than before with the same amount of money.
- 20. Causes for Deflation • Deflation can be caused by a number of factors, all of which stem from a shift in the supply-demand curve. • Remember, the prices of all goods and services are heavily affected by a change in the supply and demand, which means that if demand drops in relation towhich means that if demand drops in relation to supply, prices will have to drop accordingly. • Also, a change in the supply and demand of a nation’s currency plays an instrumental role in setting the prices of the country’s goods and services.
- 21. Causes for Deflation 1. Change in Structure of Capital Markets when many different companies are selling the same goods or services, they will typically lower their prices as a means to compete.lower their prices as a means to compete. Often, the capital structure of the economy will change and companies will have easier access to debt and equity markets, which they can use to fund new businesses or improve productivity.
- 22. Causes for Deflation 2. Increased Productivity Innovative solutions and new processes help increase efficiency, which ultimately leads to lower prices. Although someleads to lower prices. Although some innovations only affect the productivity of certain industries, others may have a profound effect on the entire economy.
- 23. Effects of Deflation • Reduced Business Revenues • Wage Cutbacks and Layoffs • Changes in Customer Spending • Reduced Stake in Investments• Reduced Stake in Investments • Reduced Credit
- 24. Bank • A bank is a financial institution licensed to receive deposits and make loans. Banks may also provide financial services, such as wealth management, currency exchange and safe deposit boxes.deposit boxes. • There are two types of banks: – Commercial/retail banks and – Central banks
- 25. Bank • Commercial banks are typically concerned with managing withdrawals and receiving deposits as well as supplying short-term loans to individuals and small businesses.to individuals and small businesses. • Central banks are chiefly responsible for currency stability, controlling inflation and monetary policy and overseeing money supply.
- 26. Central Bank Definition of Central Bank • Central Bank is the supreme financial institution that regulates the banking and monetary system of the country. It is formed to bring monetary stability, issue notes and maintain the value of a country’s currency innotes and maintain the value of a country’s currency in the international market. It administers the currency and credit system of the nation. • In India, the Reserve Bank of India plays the role of a central bank, which came into existence, after passing an act in parliament in 1934. The bank is headquartered in Mumbai, Maharashtra.
- 27. Functions of the Central Bank • It is authorized to issue currency notes except coins and notes of small magnitude. • It has the power to control, direct and supervise the commercial banks. It also helps them at the time of need. • It employs various measures to control the credit operations of the commercial banks.operations of the commercial banks. • It is the banker and advisor to the government of the country. • It acts as a manager of foreign exchange reserves. • It collects and publishes the information relating to banking and financial sector. • It oversees the credit and monetary policy of the nation.
- 28. Commercial Bank Definition of Commercial Bank • The entities that provide banking and financial services to a large number of people are known as Commercial Banks. • They act as a mediator between the borrowers• They act as a mediator between the borrowers and savers. • The Commercial Banks receive deposits from the general public and lends it on high interest to the individuals and organizations. In this way, the mobilization of savings takes place, and the economic cycle goes on smoothly.
- 29. Commercial Bank • In earlier times, people used to deposit money in post offices for saving purposes, when the requirement of the banking system was felt. • The people want an establishment where they can deposit their savings and withdraw it at thecan deposit their savings and withdraw it at the time of need. • At present, there are more than 600 commercial banks in India, which include public sector banks, private sector banks, scheduled banks, non- scheduled banks, nationalized banks, etc.
- 30. Functions of a Commercial Bank • It accepts deposits from the general public, firms, institutions and organization. Further, it gives the facility to withdraw money on demand. Banks pay interest on deposits at various rates on different deposits.different deposits. • It lends money to public, institutions, and organization in the form of long term and short term loans for a particular period and charges interest on the amount lent. Moreover, it provides overdraft and cash credit facilities to the customer.
- 31. Functions of a Commercial Bank • It performs agency functions like collections of bills of exchange and promissory notes, trading of shares and debentures, payment to third parties on standing instructions of the customer, etc. • It provides the facility of safe keeping of valuables• It provides the facility of safe keeping of valuables like jewelry and documents. • It collects, transfers and makes payment of funds on behalf of the customer. • It provides the facility of ATM card, Debit Card, Credit Card, Cheques, etc., to its account holders.
- 32. Central Bank Vs Commercial Bank Particulars Central bank Commercial bank Meaning The bank which looks after the monetary system of the country is known as Central Bank. The establishment, which provides banking services to the public, is known as Commercial Bank. What is it? It is a banker to the banks and the It is the banker to the citizens of the nation.What is it? government of the country. It is the banker to the citizens of the nation. Governing Statute Reserve Bank of India Act, 1934. Banking Regulation Act, 1949. Ownership Public Public or Private Profit motive It does not exist for making profit for its owners It exist for making profit for its owners.
- 33. Central Bank Vs Commercial Bank Particulars Central bank Commercial bank Monetary Authority It is the supreme monetary authority with wide powers. No such authority. Objective Public welfare and economic development. Earning Profits Money supply Ultimate source of money supply in the economy. No such function is performed by it.Money supply economy. No such function is performed by it. Right to print and issue currency notes Yes No Deals with General Public Banks and Governments How many banks are there? Only one Many
- 34. New Economic Environment - Liberalization, Privatization and Globalisation Model The Liberalization, Privatization and Globalization (LPG) model was developed inGlobalization (LPG) model was developed in 1991 by the then finance minister Dr. Manmohan singh under the direction of the Prime Minister Shri.P.V.Narasimha Rao .
- 35. New Economic Environment - Liberalization, Privatization and Globalisation Model Structural changes in the Indian economy were 1. End of the private sector: The government decided to transfer the loss making public sector units to the private, but there were no takers, therefore the government went for disinvestment of the public enterprises including profitfor disinvestment of the public enterprises including profit making units. 2. Government permitted private sector to set up individual units without license. 3. The investment ceiling was lifted and hence the private investment could go up to any level. 4. The Government approved up to 51% FDI. No permission was required for hiring foreign technicians and technology.
- 36. New Economic Environment - Liberalization, Privatization and Globalisation Model 5. Rehabilitation schemes to reconstruct the sick public sector enterprises. (board for industrial and financial reconstruction) BIFR was established.established. 6. Greater autonomy was given to manage Public sector units. 7. Economy was opened to other countries to encourage exports. Therefore it encouraged private participation and expected the rise in exports from India.
- 37. Reasons for Implementing the Policy of Liberalization, Privatization and Globalization 1. Excess consumption and expenditure over revenue have been experienced resulting in heavy government borrowings.heavy government borrowings. 2. Growing in-efficiency in the use of resources. 3. Mismanagement of firms and the economy. 4. Losses of public sector enterprises.
- 38. Reasons for Implementing the Policy of Liberalization, Privatization and Globalization 5. Various distortions like poor technological development, shortage of foreign exchange, borrowing, mismanagement of foreignborrowing, mismanagement of foreign exchange reserves etc., have distorted the Economic growth. 6. Low foreign exchange reserves. 7. Burden of national debt and 8. Inflationary pressure on the economy.
- 39. Weakness of LPG Model The major weaknesses of India’s LPG model were: 1. Narrow focus 2. Free entry of MNCs2. Free entry of MNCs 3. Agricultural sector was bypassed 4. Facilitated more imports 5. Capital intensive development