MONETARY POLICY
Monetary policy is an economic policy
that manages the size and growth rate
of the money supply in an economy.
It is a powerful tool to regulate
macroeconomic variables such
as inflation and unemployment.
Expansionary vs. Contractionary
Monetary Policy
Expansionary Monetary Policy
This is a monetary policy that aims to increase
the money supply in the economy by decreasing
interest rates, purchasing government securities
by central banks, and lowering the reserve
requirements for banks. An expansionary policy
lowers unemployment and stimulates business
activities and consumer spending. The overall
goal of the expansionary monetary policy is to
fuel economic growth. However, it can also
possibly lead to higher inflation.
Contractionary Monetary Policy
The goal of a contractionary monetary
policy is to decrease the money supply
in the economy. It can be achieved by
raising interest rates, selling government
bonds, and increasing the reserve
requirements for banks.
The contractionary policy is utilized
when the government wants to control
inflation levels.
Objectives of Monetary Policy
1. Inflation
Monetary policies can target inflation levels. A low
level of inflation is considered to be healthy for the
economy. If inflation is high, a contractionary policy
can address this issue.
2.Unemployment
Monetary policies can influence the level of
unemployment in the economy. For example, an
expansionary monetary policy generally decreases
unemployment because the higher money supply
stimulates business activities that lead to the
expansion of the job market.
Instruments of Monetary
Policy
Repo rate is the rate at which the central bank
of a country (Reserve Bank of India in case of
India) lends money to commercial banks in the
event of any shortfall of funds. Repo rate is
used by monetary authorities to control
inflation.
In the event of inflation, central banks
increase repo rate as this acts as a disincentive
for banks to borrow from the central bank. This
ultimately reduces the money supply in the
economy and thus helps in arresting inflation.
Reverse Repo Rate
Reverse repo rate is the rate at which the
central bank of a country (Reserve Bank of
India in case of India) borrows money from
commercial banks within the country. It is a
monetary policy instrument which can be used
to control the money supply in the country.
An increase in reverse repo rate means that
commercial banks will get more incentives to
park their funds with the RBI, thereby
decreasing the supply of money in the market.
Cash reserve Ratio (CRR)
the Cash reserve ratio is a certain
percentage of cash that all banks have
to keep with the RBI as a deposit.
This percentage is fixed by the RBI and
is changed from time to time by the
central bank itself
Objectives of Cash Reserve Ratio
Cash Reserve Ratio ensures that a part
of the bank’s deposit is with the Central
Bank and is hence, secure.
Another objective of CRR is to
keep inflation under control. During high
inflation in the economy, RBI raises the
CRR to reduce the amount of money left
with banks to sanction loans. It squeezes
the money flow in the economy,
reducing investments and bringing down
inflation.
Statutory Liquidity Ratio
Statutory Liquidity Ratio or SLR is a minimum
percentage of deposits that a commercial bank has to
maintain in the form of liquid cash, gold or other
securities. It is basically the reserve requirement that
banks are expected to keep before offering credit to
customers.
These are not reserved with the Reserve Bank of India
(RBI), but with banks themselves. The SLR is fixed by
the RBI. CRR (Cash Reserve Ratio) and SLR have been
the traditional tools of the central bank's monetary
policy to control credit growth, flow of liquidity and
inflation in the economy.
Marginal standing facility
(MSF)
Marginal standing facility (MSF) is a window for
banks to borrow from the Reserve Bank of India in
an emergency when inter-bank liquidity dries up
completely.
The Marginal standing facility is a scheme
launched by RBI while reforming the monetary
policy in 2011-12
The Marginal Standing facility allows banks to
borrow money with an interest rate above the repo
rate and can be termed as the Marginal standing
facility rate.
The Monetary Policy Committee
1. Governor of the Reserve Bank of India—Chairperson, ex officio;
2. Deputy Governor of the Reserve Bank of India, in charge of
Monetary Policy—Member, ex officio;
3. One officer of the Reserve Bank of India to be nominated by
the Central Board—Member, ex officio;
4. Prof. Ashima Goyal, Professor, Indira Gandhi Institute of
Development Research —Member;
5. Prof. Jayanth R. Varma, Professor, Indian Institute of
Management, Ahmedabad—Member; and
6. Dr. Shashanka Bhide, Senior Advisor, National Council of
Applied Economic Research, Delhi—Member.
The MPC determines the policy repo rate required
to achieve the inflation target.
The MPC is required to meet at least four times in
a year. The quorum for the meeting of the MPC is
four members.
Each member of the MPC has one vote, and in the
event of an equality of votes, the Governor has a
second or casting vote.
Each Member of the Monetary Policy Committee
writes a statement specifying the reasons for
voting in favor of, or against the proposed
resolution.
