Monetary Policy Knows about Monetary and various polices

Monetary Policy

1. Monetary Policy Monetary Policy - Meaning & Overview In simpler words, monetary policy can be defined as using the monetary instruments under the guidance of the RBI for regulating interest rates, availability of credit, money supply, etc. so as to achieve the ultimate goal of economic policy. The central bank or the RBI is responsible for formulating and implementing such monetary policies in India. The RBI controls inflation in the country through monetary policy. Monetary tools : Reverse Repo Rate, SLR, CRR, Repo Rate, etc.

2. Objectives of Monetary Policy : The main objectives of monetary policy are the management of inflation, maintenance of currency exchange rates, unemployment, and so on. Following are the objectives of monetary policy in India: Unemployment: Monetary policies play a significant role in regulating the unemployment levels in the economy. For instance, an expansionary monetary policy would decrease the unemployment levels as the higher money supply would influence business activities that would lead to the increase in employment opportunities. Regulating the exchange rates : The RBI uses its fiscal authority to regulate the exchange rates between domestic and foreign currencies. For instance, the RBI can increase the money supply by issuing more currency. In that case, the domestic currency becomes relatively cheaper than its foreign counterparts.

3. Inflation : Monetary policies also target the levels of inflation. When there is a low level of inflation, it is considered to be a sound situation for the economy. In case of high inflation levels, a contractionary monetary policy can resolve the issue . Expansionary & Contractionary Monetary Policy A monetary policy can be of two types - expansionary or contractionary Expansionary Monetary Policy • Focuses on expanding or increasing the supply of money in an economy • A monetary policy which is expansionary in nature is implemented by decreasing the interest rates, thus increasing the market liquidity.

4. Contractionary Monetary Policy • Focuses on contractions or decreasing the money supply in an economy. • A contractionary monetary policy is carried out by increasing the interest rates, resulting in reduced market liquidity.

5. Monetary Policy Process (MPP) The Monetary Policy Committee , also known as MPC, is responsible for determining the policy interest rates needed to resolve inflation. It is the RBI’s Monetary Policy Department (MPD ) that assists the MPC to formulate the monetary policy in the country. The analytical assistance by the RBI along with the views of the key stakeholders in the economy contribute in the process of making a policy repo rate decision. The Financial Markets Operations Department (FMOD) carries out the monetary policy by way of dayto -day liquidity management operations. The Financial Market Committee (FMC) conducts a daily meeting to review the liquidity conditions in the economy. This is done to ensure that the operating target of the monetary policy is inline with the policy repo rate. It is also known as the Weighted Average Call Money Rate (WACR)

6. Instruments of Monetary Policy The instruments of monetary policy are categorized as direct instruments and indirect instruments. Before looking at the sub-types, let us learn more about the difference between direct instruments and indirect instruments of monetary policy in India. Direct Instruments These are used to set/ limit prices (interest rates) or quantities (credit) through regulations. They are in the form of credit ceilings and mainly aimed at the balance sheets of the commercial banks They are non-market-oriented. Eg . SLR and CRR

7. Indirect Instruments These operate through the market by influencing the underlying demand and supply conditions. They focus on the balance sheet of the Reserve Bank. They are also known as market-based instruments. Eg . Bank Rate, MSF, Repo Rate, Reverse Repo Rate. The following section elaborates each of the monetary policy instrument in detail: CRR (Cash Reserve Ratio) • CRR is the average daily balance that a bank is needed to maintain with the RBI, one of the prime regulators of banks and financial institutions. • The CRR is a share of such a percentage of its NDTL (Net Demand and Time Liabilities) that the RBI may alter on a regular basis in the Gazette of India.

8. SLR (Statutory Liquidity Ratio) • The SLR is the share of NDTL that banks are mandated to maintain in the form of safe and liquid assets. These include government securities, cash, and gold. If there is any change in the SLR, it influences the availability of resources in the banking industry for extending loans to the private sector. Repo Rate • The rate of interest the RBI charges from its customer base on their short-term borrowings is the Repo Rate. Hence, it is basically an abbreviated form of “rate of purchase”. • In practical form, it is not called an interest rate. Instead, it is considered as a discount on the dated government securities that are deposited by the institution to borrow for a short term. • Repo Rate is fixed to be in the range of 5% to 9%

9. Reverse Repo Rate • It is the rate of interest that the RBI pays to its customer base that offers short-term loans to it. • As the name suggests, it is the reverse of the repo rate and it was started in November 1966 as a part of the LAF (Liquidity Adjustment Facility) by the RBI. An LAF enables the banks to get money through repurchase agreements. • The Reverse Repo Rate is utilized by the RBI in the wake of over money supply with the banks and lower loan disbursal to serve both the purposes of cutting down losses in the prevailing interest rates. • The reverse repo rate ranges from 5% to 9%