Monetary Policy Of RBI

Banking & Financial Sector

Introduction

Monetary policy is the process by which the government, central bank or monetary authority of a country controls.

(i) the supply of money

(ii) availability of money

(iii) cost of money or rate of interest

In order to attain a set of objectives oriented towards the growth and stability of the economy.

Objectives of Monetary Policy

⚫ To ensure a stable currency value

⚫ Price stability

⚫ Economic stability or full employment

⚫ Rapid economic growth

⚫ Balance of payments equilibrium

⚫ Greater equality in distribution of income & wealth ⚫ To maintain continuously low rate of interest

⚫ To create a continuous market for government securities

⚫ To provide credit at differential rate of interest

• The most dominant objective of monetary policy is Price Stability.

• Price stability does not mean complete year-to-year price stability which is difficult to attain.

• Price stability refers to the long run average stability of prices.

• Price stability involves avoidance of both inflationary and deflationary pressures.

Most Important Objective of Monetary Policy

• Price Stability contributes improvements in the standard of living of people.

• Stable prices enable exports to compete in international markets and contribute to the strengthening of BoP.

• It contributes to the overall financial stability of the economy.

Types of Monetary Policy

Expansionary policy

• It increases the total supply of money in the economy.

• It is used to combat unemployment in a recession by lowering interest rates.

Contractionary policy

• It decreases the total supply of money in the economy.

• It is used to combat Inflation by increasing the interest rates.

Instruments Of Monetary Policy

Quantitative Tools Qualitative Tools

Quantitative Tools

Reserve Ratios

Policy Rates

Liquidity Adjustment Facility Marginal Standing Facility

Minimum 5 crore Minimum 1 crore

All clients are eligible like NBFCs also

Only Scheduled Commercial banks

No SLR quota securities Can use SLR quota securities

No limit on loans Maximum loan- 1% of NDTL

Interest rate- E.g. 5% Interest rate, usually 5%+0.25%

Open Market Operations

Policy Dear Money Cheap Money

EXPANSIONARY MONETARY POLICY

Problem: Recession and unemployment

Measures: (1) Central bank buys securities through open market operation

(2) It reduces cash reserve ratio

(3) It lowers the bank rate

Money supply increases

Investment increases

Aggregate demand increases

Aggregate output increases by a multiple of the increase in investment

TIGHT MONETARY POLICY

Problem: Inflation Measures: (1) Central bank sells securities through OMO

(2) It raises CRR and SLR

(3) It raises bank rate

(4) It raises maximum margin against holding of stocks of goods

Money supply decreases

Interest rate raises

Investment expenditure declines

Aggregate demand declines

Price level falls

Qualitative Tools

Qualitative credit is used by the RBI for selective purposes.

Margin requirements:-

• This refers to difference between the securities offered and amount borrowed by the banks.

Rationing of credit:-

• The RBI controls the Credit granted / allocated by commercial banks.

Consumer Credit Regulation:-

• This refers to issuing rules regarding down payments & maximum maturities of installment credit for purchase of goods.

Moral Suasion:-

• Psychological means and informal means of selective credit control.

Guidelines:-

• RBI issues oral, written statements, appeals, guidelines, warnings etc. to the banks.

Direct Action:-

• This step is taken by the RBI against banks that don’t fulfill conditions and requirements.