Limitation of bank rate, Managerial Economics

Assignment Help:

Limitation

The degree or success with which the central bank can use its bank rate policy to control the total credit in the economy depends upon the interest elasticity of investment demand. During boom the demand for bank credit by the business community may be highly interest inelastic. When the entrepreneurs are over optimistic and consequently the marginal productivity of investment in high. The demand for bank credit cannot be curtailed simply by raising the bank rate by the central bank . if the investors expect that the value of their investment will appreciate, say by 10 per cent annum then even a rise of a as high as 10 per cent per annum in the money interest rate will not deter them from borrowing from the commercial banks. Moreover, in many business undertakings interest rate constitutes a negligible proportion of the total unit cost of production . consequently , for such business the demand for bank credit is highly interest inelastic. Although in the long period the bank rate is bound to influence the stock market and the business yield expectations, but it may be too late to cheek evil when the seeds of destruction have been already sown.

The bank rate policy proves more ineffective during depression than during the boom. Any depression involves tedious readjustments of one type or the other. Serious depression gives a sharp blow to business confidence which only a considerable time factor can revive. Consequently, at this time the demand for bank credit become highly interest inelastic. Businessmen do not borrow even at the maximum facilities provided by the commercial banks. When sales are falling off quickly an idle plant capacity in increasing over the entire community, the investors cannot be easily persuaded to increase or even to continue the flow of their borrowing . Nobody will install any new plant for a remote and uncertain demand. Even if the interest rate falls to zero, or even becomes negative (which is not possible ) no inducement to invest may be caused. If the fall in prices is expected to continue, no conceivable fall in its bank rate by the central bank and through it in the lending rates of the commercial bank will initiate recovery in the economy in the economy. Thus the bank rate policy suffers from serious limitations and central bank cannot eliminate the occurrence of both and s slump from the economy merely by raising or lowering the bank rate.


Related Discussions:- Limitation of bank rate

Compettitive market, Tomato Farm is selling tomatoes in a purely competitiv...

Tomato Farm is selling tomatoes in a purely competitive market. Its output is 5000 bushels, which sell for $15 a bushel. At this level of output, the marginal cost is $15 bushel an

Fixed exchange rate, Country A has a fixed exchange rate with country B. Du...

Country A has a fixed exchange rate with country B. Due to a recession in country B, demand for A's goods falls. Draw what would happen on the graph below. On the graphs, draw what

Demand forecasting, what is the importance of demand forecasting to manager...

what is the importance of demand forecasting to managers

Managerial economics problem, Suppose there are two types of T-shirts: bran...

Suppose there are two types of T-shirts: branded ones and unbranded ones and people allocate their spending in a way that they buy both types. Suppose the price of branded T-shirts

Functions of commercial banks, Functions of Commercial Banks In modern...

Functions of Commercial Banks In modern economy, commercial banks have the following functions: i.     They provide a safe deposit for money and other valuables. ii.

Least cost factor combination, Producers Equilibrium or Optimal Combination...

Producers Equilibrium or Optimal Combination of Inputs  The analysis of production function has demonstrated that alternative combinations of factors of production that are tech

Managerial economic, gap between economic theory and business practice

gap between economic theory and business practice

Explain the term- takes the help of macroeconomics, Takes the help of macro...

Takes the help of macroeconomics Managerial economics incorporates certain aspects of macroeconomic theory. These are important to comprehending the circumstances and environme

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd