Monetary Policy is the way to control the supply of money and credit cost in the economy. It is constructed by the Central Bank i.e., the Reserve Bank of India. The policy manages the allotment of credit among users and interest rates on lending and borrowing. The role of monetary policy is promoting economic growth. It is also known as the Money Management Policy or Credit Policy of RBI.
Purpose of Monetary Policy
Price Stability: The monetary policy is also designed to keep the country’s inflation under control. Inflation and deflation can occur in every economy, both of which are destructive to the economy. As a result, the RBI must strike a proper balance between adopting an “easy money policy” during a recession and adopting a “dear money policy” during an inflationary tendency.
Exchange rate Stability: Another essential goal is to keep the domestic currency’s exchange rate constant to foreign currencies. The foreign community loses confidence in the economy when the exchange rate fluctuates. As a result, maintaining exchange rate stability is a requirement of monetary policy.
Balance of Payment(BOP): The ‘BOP surplus’ and ‘BOP deficit’ are two characteristics of the BOP. The former denotes an overabundance of money in the domestic economy, whereas the latter denotes monetary tightening. The BOP equilibrium can be established if monetary policy succeeded in sustaining monetary equilibrium.
Economic Growth: If the RBI adopts the policy, it will do so by lowering interest rates, which will boost the country’s investment outlook. As a result, economic growth would be boosted. However, if monetary policy succeeds in sustaining income and price stability, faster economic development is feasible.
Monetary Policy Quantitative Instruments
- The rate at which the Reserve Bank of India discounts bills for commercial banks.
- Commercial and cooperative banks, the Industrial Development Bank of India, the International Finance Corporation, the Export-Import Bank, and other licensed financial organizations are all part of this banking system.
- Funds are obtained through direct lending, rediscounting, or the purchase of money market products such as Commercial Bills and Treasury Bills.
- Increases in the Bank Rate raise the cost of borrowing for commercial banks, resulting in a fall in lending volume to banks and, as a result, a reduction in the money supply.
- An increase in the Bank Rate indicates that the RBI’s monetary policy is being tightened.
- The rate at which Commercial Banks borrow money from the Reserve Bank of India.
- A decrease in the Repo Rate enables Commercial Banks to obtain funds at a lower cost, whereas an increase in the Repo Rate discourages Commercial Banks from obtaining funds as the rate rises and becomes more expensive.
- As the Repo Rate increases, banks’ borrowing and lending costs will also increase, deterring the public from borrowing and promoting them to deposit.
Reverse Repo Rate
- The rate at which the RBI borrows money from commercial banks.
- If there is an increase in reverse repo rate, the money supply falls, and vice versa, assuming all other variables stay constant.
- If the Reverse Repo Rate increase, Commercial Banks will be more enticed to park their cash with the RBI, This will reduce the amount of money available in the market.
- Increases in the Repo Rate and the Reverse Repo Rate imply that the RBI’s Monetary Policy is being strengthened.
Cash reserve ratio(CRR)
- The cash reserve ratio refers to the amount that commercial banks must keep in cash with the Reserve Bank of India.
- If the RBI believes the economy has a big amount of money supply, it may raise the CRR. If it believes that inflation is under control and that the economy needs monetary stimulus, it will lower the CRR.
- The lower CRR will put more money in the hands of commercial banks, who will then pass it on to the industry.
- The industry will benefit from more money, which will increase production, consumption, and employment.
Statutory Liquidity Ratio(SLR)
- The statutory liquidity ratio is the amount that commercial banks are required to hold on hand. SLR stands for the amount of money that banks are required to hold in their custody at all times.
- SLR is also a very effective instrument for controlling the economy’s liquidity.
- SLR may be reduced to put more money in the hands of commercial banks to encourage companies to increase production.
- An increase in the SLR is used as an inflation control measure to keep prices from rising too quickly.
The main goal of RBI Monetary Policy is to bring price stability to the country and economic growth. Monetary policy also affects Stock Market. To know how ‘Click Here‘.
When time to time necessary RBI keeps on changing the rates and bringing amendments in the policy to stay closer to its goal.