Monetary Policy
Notes
Monetary policy is the RBI's regulation of the money supply, credit and interest rates to achieve price stability (the primary objective) while supporting growth. The RBI was established on 1 April 1935 under the RBI Act, 1934 (on the Hilton Young Commission's recommendation) and was nationalised in 1949.
Monetary Policy Committee (MPC) (RBI Act, Section 45ZB; since 2016)
- Six members: the RBI Governor (Chair, with a casting vote), the Deputy Governor in charge of monetary policy, one other RBI officer, and three external members nominated by the Government (four-year terms). It meets at least four times a year; decisions are by majority.
Instruments
Instrument | Meaning |
|---|---|
Repo rate | The rate at which the RBI lends to banks against government securities; the main policy rate. Cut to ease credit; raised to curb inflation |
Standing Deposit Facility (SDF) rate | The rate at which banks park surplus funds with the RBI without collateral; the floor of the LAF corridor (repo minus 0.25%) |
Marginal Standing Facility (MSF) rate | The rate for emergency overnight borrowing by banks against their SLR securities; the ceiling (repo plus 0.25%); the Bank Rate equals the MSF rate |
Cash Reserve Ratio (CRR) | The share of a bank's net demand and time liabilities (NDTL) kept with the RBI as cash (no interest) |
Statutory Liquidity Ratio (SLR) | The share of NDTL banks hold as liquid assets (cash, gold, government securities) with themselves |
Open Market Operations (OMO) | The RBI buys (injects liquidity) or sells (absorbs) government securities |
Liquidity Adjustment Facility (LAF) | Daily repo and reverse repo operations (introduced in 2000); also variable rate repo/reverse repo auctions |
Market Stabilisation Scheme (MSS) | Sterilisation of surplus liquidity by issuing securities (2004) |
Qualitative tools | Moral suasion, margin requirements, selective credit control |
Stance and transmission
- Accommodative (easing), neutral, withdrawal of accommodation or tightening. Expansionary ("cheap money": lower rates) vs contractionary ("dear money": higher rates).
- Transmission: a change in the repo rate passes to the External Benchmark-linked Lending Rate (EBLR) and MCLR, and then to loan and deposit rates; the pass-through is often partial and slow.
- Money supply measures: M0 (reserve money), M1 (narrow money: currency plus demand deposits), M2 (M1 plus post office savings), M3 (broad money: M1 plus time deposits). The money multiplier is roughly the inverse of the reserve ratio.
Monetary vs fiscal policy: monetary policy is by the RBI (money, credit and interest rates); fiscal policy is by the Government (taxation, spending and borrowing).
Current rates (repo, CRR, SLR) change with RBI decisions, so check the latest RBI announcement.
Key Points
- Monetary policy by the RBI; the primary goal is price stability.
- MPC has six members, the Governor casting the deciding vote.
- Repo is the main policy rate; the SDF is the floor and the MSF the ceiling of the corridor.
- CRR (cash with RBI) and SLR (liquid assets with banks) control liquidity.
- OMOs, LAF and moral suasion are other tools; transmission through EBLR.
MCQs
Q1. The main policy rate of the RBI is the:
(a) Bank rate
(b) Repo rate
(c) CRR
(d) SLR
Ans: (b) .
Q2. The Monetary Policy Committee consists of how many members?
(a) 4
(b) 5
(c) 6
(d) 7
Ans: (c) . Three from the RBI and three external members.
Q3. The Cash Reserve Ratio is the percentage of NDTL that banks must keep:
(a) With themselves in gold
(b) With the RBI as cash
(c) In government securities
(d) In foreign currency
Ans: (b) .