Monetary Policy Committee – UPSC Prelims

By /
Monetary Policy
  • It is the macroeconomic policy laid down by the central bank.
  • It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
  • In India, monetary policy of the Reserve Bank of India is aimed at managing the quantity of money in order to meet the requirements of different sectors of the economy and to increase the pace of economic growth.
  • The RBI implements the monetary policy through open market operations, bank rate policy, reserve system, credit control policy, moral persuasion and through many other instruments.
  • The amended RBI Act, 1934 provides for the inflation target (4% +-2%) to be set by the Government of India, in consultation with the Reserve Bank, once in every five years.
Accommodative and Tight Monetary Policy
  • To avoid inflation, most central banks alternate between the accommodative monetary policy and the tight monetary policy in varying degrees to encourage growth while keeping inflation under control.
  • Accommodative monetary policy is adopted when central banks expand the money supply to boost the economy.
  • These measures are meant to make money less expensive to borrow and encourage more spending.
  • A tight monetary policy is implemented to contract economic growth.
  • Converse to accommodative monetary policy, a tight monetary policy involves increasing interest rates to constrain borrowing and to stimulate savings.
Various instruments of Monetary Policy:
  • Repo Rate:
    • The interest rate at which the Reserve Bank provides overnight liquidity to banks against the collateral of government and other approved securities under the liquidity adjustment facility (LAF).
  • Reverse Repo Rate:
    • The interest rate at which the Reserve Bank absorbs liquidity, on an overnight basis, from banks against the collateral of eligible government securities under the LAF.
  • Liquidity Adjustment Facility (LAF):
    • The LAF consists of overnight as well as term repo auctions.
    • The aim of term repo is to help develop the interbank term money market, which in turn can set market based benchmarks for pricing of loans and deposits, and hence improve transmission of monetary policy.
    • The RBI also conducts variable interest rate reverse repo auctions, as necessitated under the market conditions.
  • Marginal Standing Facility (MSF):
    • A facility under which scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest.
    • This provides a safety valve against unanticipated liquidity shocks to the banking system.
  • Corridor:
    • The MSF rate and reverse repo rate determine the corridor for the daily movement in the weighted average call money rate.
  • Bank Rate:
    • It is the rate at which the RBI is ready to buy or rediscount bills of exchange or other commercial papers. The Bank Rate is published under Section 49 of the RBI Act, 1934.
    • This rate has been aligned to the MSF rate and, therefore, changes automatically as and when the MSF rate changes alongside policy repo rate changes.
  • Cash Reserve Ratio (CRR):
    • The average daily balance that a bank is required to maintain with the Reserve Bank as a share of such per cent of its Net demand and time liabilities (NDTL) that the Reserve Bank may notify from time to time in the Gazette of India.
  • Statutory Liquidity Ratio (SLR):
    • The share of NDTL that a bank is required to maintain in safe and liquid assets, such as, unencumbered government securities, cash and gold.
    • Changes in SLR often influence the availability of resources in the banking system for lending to the private sector.
  • Open Market Operations (OMOs):
    • These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.
  • Market Stabilisation Scheme (MSS):
    • This instrument for monetary management was introduced in 2004.
    • Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through sale of short-dated government securities and treasury bills.
    • The cash so mobilised is held in a separate government account with the RBI.
Previous Year Questions:
Q 1. With reference to Indian economy, consider the following: (2015)
  1. Bank rate
  2. Open market operations
  3. Public debt
  4. Public revenue
Which of the above is/are component/ components of Monetary Policy?
(a) 1 only
(b) 2, 3 and 4
(c) 1 and 2
(d) 1, 3 and 4
Ans: (c)
Q 2. If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do? (2020)
  1. Cut and optimise the Statutory Liquidity Ratio
  2. Increase the Marginal Standing Facility Rate
  3. Cut the Bank Rate and Repo Rate
Select the correct answer using the code given below:
(a) 1 and 2 only
(b) 2 only
(c) 1 and 3 only
(d) 1, 2 and 3
Ans: (b)

Leave a Comment

Your email address will not be published. Required fields are marked *

Scroll to Top