What is the Monetary Policy?• It is the process by which monetary authorityof a country, generally a central bank controlsthe supply of money in the economy byexercising its control over interest rates inorder to maintain price stability and achievehigh economic growth.In India, the centralmonetary authority is the RBI.Monetary policyis so designed as to maintain the price stabilityin the economy.
How is the Monetary Policy differentfrom the Fiscal Policy?• The Monetary Policy regulates the supply of money and the costand availability of credit in the economy. It deals with both thelending and borrowing rates of interest for commercial banks.• The Monetary Policy aims to maintain price stability, fullemployment and economic growth.• The Monetary Policy is different from Fiscal Policy as the formerbrings about a change in the economy by changing money supplyand interest rate, whereas fiscal policy is a broader tool with thegovernment.• The Fiscal Policy can be used to overcome recession and controlinflation. It may be defined as a deliberate change in governmentrevenue and expenditure to influence the level of national outputand prices.
What are the objectives of theMonetary Policy?• The objectives are to maintain price stability andensure adequate flow of credit to the productivesectors of the economy.Stability for the national currency (after lookingat prevailing economic conditions), growth inemployment and income are also looked into.The monetary policy affects the real sectorthrough long and variable periods while thefinancial markets are also impacted throughshort-term implications.
INSTRUMENTS OF MONETARY POLICY• 1. Bank Rate of Interest• 2. Cash Reserve Ratio• 3. Statutory Liquidity Ratio• 4. Open market Operations• 5. Margin Requirements• 6. Deficit Financing• 7. Issue of New Currency• 8. Credit Control
Bank Rate of InterestIt is the interest rate which is fixed by the RBI to control thelending capacity of Commercial banks . During Inflation , RBIincreases the bank rate of interest due to which borrowingpower of commercial banks reduces which thereby reduces thesupply of money or credit in the economy .When Moneysupply Reduces it reduces the purchasing power and therebycurtailing Consumption and lowering Prices.
Cash Reserve RatioCRR, or cash reserve ratio, refers to a portion of deposits (ascash) which banks have to keep/maintain with the RBI. DuringInflation RBI increases the CRR due to which commercialbanks have to keep a greater portion of their deposits withthe RBI . This serves two purposes. It ensures that a portion ofbank deposits is totally risk-free and secondly it enables thatRBI control liquidity in the system, and thereby, inflation.
Statutory Liquidity RatioBanks are required to invest a portion of theirdeposits in government securities as a part oftheir statutory liquidity ratio (SLR)requirements . If SLR increases the lendingcapacity of commercial banks decreasesthereby regulating the supply of money in theeconomy.
Open market OperationsIt refers to the buying and selling of Govt.securities in the open market . During inflationRBI sells securities in the open market whichleads to transfer of money to RBI.Thus moneysupply is controlled in the economy.
Margin Requirements• During Inflation RBI fixes a high rate of marginon the securities kept by the public for loans.If the margin increases the commercial bankswill give less amount of credit on thesecurities kept by the public therebycontrolling inflation.
Deficit Financing• It means printing of new currency notes byReserve Bank of India .If more new notes areprinted it will increase the supply of moneythereby increasing demand and prices.• Thus during Inflation, RBI will stop printingnew currency notes thereby controllinginflation.
Issue of New Currency• During Inflation the RBI will issue newcurrency notes replacing many old notes.This will reduce the supply of money in theeconomy.