This article discussed the Reserve Bank of India’s monetary policy. Learn more about the RBI Monetary Policy Committee, Monetary Policy Objectives, and Monetary Policy Instruments. Most importantly It is one of the important topic for your UPSC examination. There have been several changes in the way India’s monetary policy has been formulated recently.
- What is Monetary Policy?
- What is Monetary Policy Committee (MPC)?
- What are the Objectives of This Policy?
- Monetary Policy Instruments (MPI)?
- Editor's Note | RBI Monetary Policy
What is Monetary Policy?
RBI Monetary policy is a set of actions taken by a country’s central bank to manage the overall money supply and ensure long-term economic growth. So Expansionary and contractionary monetary policy are the two basic categories of monetary policy and goal is to manage money in order to suit the needs of various sectors of the economy. Monetary policy is used by the Reserve Bank of India (RBI) to control inflation in India. RBI uses the various instrument to achieve its purpose. Further, In this article, we will also talk about these instruments.
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Expansionary and contractionary monetary policy are the two basic categories of RBI monetary policy:
- The goal of an expansionary monetary policy is to increase the money supply in a given economy. Lowering key interest rates and enhancing market liquidity are used to implement an expansionary monetary policy.
- The goal of contractionary monetary policy is to reduce the money supply in an economy. Increases in key interest rates, which reduce market liquidity, are used to achieve a contractionary monetary policy.
What is Monetary Policy Committee (MPC)?
The Monetary Policy Committee (MPC), which was established under section 45ZB of The Reserve Bank of India Act, 1934, met for the 29th time from June 2 to 4, 2021. Further, let’s talk about the committee.
The Monetary Policy Committee (MPC)
The Monetary Policy Committee (MPC) is a committee chaired by the Governor of the Reserve Bank of India. It was established with the goal of setting the benchmark policy interest rate. Prior to the formation of the committee, the Governor of the Reserve Bank of India made all of the major interest rate decisions on his own. The committee consists of an internal team and a technical advisory group.
The MPC is a central government-appointed six-person committee (Section 45ZB of the amended RBI Act, 1934). At least 4 times a year, the MPC must convene. Therefore A quorum of four members is required for the MPC meeting. Each Monetary policy committee member has one vote, with the Governor having a second or casting a vote in the event of a tie.
In addition, The Reserve Bank is obligated to publish the Monetary Policy Report every six months to explain the drivers of inflation as well as the inflation prediction for the following six to eight months.
What are the Objectives of This Policy?
The primary objective of monetary policy is to keep price stability while also pursuing the goal of growth, and high employment, as price stability is a prerequisite for long-term economic growth. The Reserve Bank of India is in charge of managing inflation through a detailed consultation process. As a result, India’s present inflation-targeting system is adaptable.
The following are the Objectives of RBI Monetary Policy:
- Price Stability: The most genuine purpose of monetary policy is price stability. Because cyclical variations are completely avoided, stable prices restore public confidence. It encourages economic activity and ensures that income and wealth are distributed fairly.
- Employment Generation: A country’s monetary policy can influence the rate of investment and how it is allocated among various economic activities with variable labor intensities. As a result, it aids in the creation of jobs.
- Managing business cycles: A business cycle has two major stages: boom and depression. Monetary policy is the most powerful weapon for controlling business cycle booms and busts by managing credit to manage the availability of money. Market inflation can be managed by lowering the supply of money. On the other hand, as the money supply expands, so makes the demand for goods and services in the economy.
- Priority Sector Promotion: Agriculture, export, small-scale enterprises, and the poorer segment of the population are all priority sectors in India. It is constantly guarantees that the banking sector provides timely and appropriate credit to these groups at reasonable rates.
- Rates of currency conversion: A central bank can control exchange rates between local and foreign currencies by using its fiscal authorities. The central bank, for example, may raise the money supply by issuing additional currency. The indigenous currency gets cheaper in comparison to its international counterparts in this situation.
- Controlled Expansion Of Bank Credit: The controlled expansion of bank credit and money supply, with special attention to seasonal credit requirements, is one of the RBI’s most essential duties.
Monetary Policy Instruments (MPI)?
For the implementation of monetary policy, a variety of direct and indirect instruments are used.
RBI’s monetary policy includes some of the following instruments:
- Repo Rate: The repo rate is when the Reserve Bank of India lends money to its customers in exchange for government assets. Commercial banks can acquire funds at a reduced cost when the repo rate falls; however, when the rate rises and becomes more expensive, commercial banks are discouraged from receiving funds.
- Reverse Repo Rate: The reverse repo rate is the interest rate at which the RBI borrows funds from commercial banks. As the repo rate rises, the cost of borrowing and lending for banks will discourage consumers from borrowing and push them to deposit.
- Liquidity Adjustment Facility (LAF): Auctions for overnight and term repo/reverse repo. The Reserve Bank has gradually boosted the amount of liquidity infused into the LAF through term-repos. The term repo’s purpose is to assist in the development of the interbank term money market, which may then create market-based benchmarks for loan and deposit pricing, thereby improving monetary policy transmission. As market conditions demand, the Reserve Bank also holds variable interest rate reverse repo auctions.
The Following Are Other Instruments
- Marginal Standing Facility (MSF): Scheduled commercial banks can borrow additional overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a specific level and paying a penalty rate of interest. In the event of unforeseen liquidity shocks, this serves as a safety valve for the banking system.
- Bank Rate: It’s the price at which the Reserve Bank will buy or sell bills of exchange or other commercial papers. The Bank Rate is required to be published under Section 49 of the Reserve Bank of India Act, 1934 This rate has been matched with the MSF rate, and as a result, it changes automatically when both the MSF and policy repo rates change.
- Cash Reserve Ratio: The Cash Reserve Ratio, or CRR, is the minimum amount of public deposits held by commercial banks that must be maintained as determined by the Central Bank. The CRR has been lowered from 15% in 1990 to 5% in 2002. The CRR is now at 4% as of December 31st, 2019.
In conclusion, it is clear that monetary policy implementation plays a critical role in a country’s development. Monetary policy refers to the use of financial instruments controlled by the central bank to regulate magnitudes such as interest rates, credit availability, and money supply in order to achieve the ultimate goal of economic policy. The first thing to remember is, This topic is essential for your UPSC, So don’t forget to make notes.
The Reserve Bank of India mandates the Cash Reserve Ratio or CRR. CRR was determined by the Monetary Policy Committee of the RBI.
The rise in the price of most ordinary or common goods and services, such as food, housing, clothing, recreation, transportation, and consumer staples is inflation. The average change in the price of a basket of goods and services over time is defined as inflation. Deflation is the inverse of inflation and refers to a drop in a collection of items’ price index. Inflation is the loss of a country’s currency unit’s buying power.
The primary objective of monetary policy is to maintain price stability while also pursuing the goal of growth, and high employment, as price stability is a prerequisite for long-term economic growth.
Some of the Instruments of monetary policy are Interest rate adjustment, Repo Rate, Reverse repo rate, Cash reserve ratio, Bank rate, and so on.
Editor’s Note | RBI Monetary Policy
After reading the preceding article, you will have a better understanding of the RBI’s monetary policy in India, including what the monetary policy committee is and what the policy’s aims and instruments are. Also, This is an important topic for IAS and other competitive exams. Once properly understood, the subject is elementary. Go fearlessly in the direction of your objectives and live your life the way you wish. Maintain a positive outlook on life. We wish you all the best!!