Monetary policy refers to actions undertaken by central banks to regulate money supply and credit conditions in order to meet macroeconomic goals like price stability, employment levels, and economic growth. The Reserve Bank of India uses both quantitative and qualitative tools to implement monetary policy in India. Quantitative tools include repo and reverse repo rates, cash reserve ratios, and open market operations. The objectives of Indian monetary policy are high growth, full employment, price stability, and a healthy balance of payments.

1. Monetary Policy

2. Definition
Monetary policy refers to a programme of action
undertaken by the monetary authorities , generally the
central bank, to control and regulate the supply of
money with the public and the flow of credit with a view
to achieving predetermined macroeconomic goals
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3. Scope of Monetary Policy
Depends on the level of monetization of the economy
Level of development of the capital market
https://www.youtube.com/watch?v=rcPEkmstDek
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4. Instruments of Monetary policy
Quantitative Tools
Bank Rate. It is 9.00% (w.e.f. 28/01/2014)
Open Market Operations
Cash Reserve Ratio. It is 4.00% (wef 09/02/2013)
Statutory Liquidity Requirement: the proportion of total
deposits which commercial banks are statutorily required to
maintain in the form of liquid assets i.e., cash reserve, gold and
government bonds in addition to CRR. To prevent the
commercial banks from liquidating their assets when CRR is
raised. It is 22.00%(w.e.f. 09/08/2014)
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5. Repo Rate & Reverse Repo Rate
Repo Rate
Discount rate at which a Central Bank repurchases
government securities from the commercial banks ,
depending on the level of money supply it decides to
maintain in the country’s monetary system.
 To temporarily expand the money supply, the central bank
decreases repo rate.
At present it is 8.00% (w.e.f.28/01/2014)
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6. Reverse Repo Rate
The rate at which RBI borrows money from the banks (or banks lend
money to the RBI) is termed the reverse repo rate.
 The RBI uses this tool when it feels there is too much money floating in
the banking system
If the reverse repo rate is increased, it means the RBI will borrow
money from the bank and offer them a lucrative rate of interest. As a
result, banks would prefer to keep their money with the RBI (which is
absolutely risk free) instead of lending it out (this option comes with a
certain amount of risk)
Consequently, banks would have lesser funds to lend to their customers.
This helps stem the flow of excess money into the economy
Reverse repo rate signifies the rate at which the central bank absorbs liquidity
from the banks, while repo signifies the rate at which liquidity is injected.
 7.00% (w.e.f.28/01/2014)
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7. Call Rate
Call rate is the interest rate paid by the banks for lending and
borrowing for daily fund requirement. Since banks need
funds on a daily basis, they lend to and borrow from other
banks according to their daily or short-term requirements on
a regular basis.
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8. Qualitative Tools
 Change in Lending Margins: banks advance loans only up to
certain percentage of the mortgaged property .Gap between
value of the mortgage property and amount advanced is
called ‘lending margin’.
 Example: if value of stock is Rs. 10 million and amount
advanced is only Rs 6 million, the lending margin is 40 %.
 Credit Rationing
 Moral Suasion
 Direct Action
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9. Monetary Policy of India
Historically, the monetary policy was announced twice a
year—a slack-season policy (April–September) and a
busy-season policy (October–March) in accordance with
agricultural cycles. These cycles also coincide with the
halves of the financial year.
Initially, the RBI used to announce all its monetary
measures twice a year in the monetary and credit policy.
 The monetary policy has now become dynamic in
nature as RBI reserves its right to alter it from time to
time, depending on the state of the economy.
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10. Objectives of Monetary Policy
High rate of growth
Fuller employment
Price stability
Greater equality in the distribution of income and wealth
Healthy balance in balance of payments
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11. The Limitations of Monetary Policy
The Time Lag refers to time taken in chalking out the policy
action, its implementation and response time.
Inside time lag is the time lost in identifying the nature of
problem, identifying the sources of problem, assessing the
magnitude of problem, choice of appropriate policy action and
implementation of policy actions
Outside lags refers to the time taken by the households and firms
to react to the policy action taken by the monetary authorities.
If preparatory and operational lags are long , not only the nature
and magnitude of problem may change rendering the policy
ineffective, but also it may worsen the situation
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12. Problems in Forecasting
Creation of policy requires that the magnitude of recession
or inflation is correctly assessed , as it helps in determining
the dose of the medicine.
It is ,thus, important to forecast these variables with suitable
and reliable forecasting techniques and hence formulation of
an appropriate monetary policy has remained an extremely
difficult task.
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13. NBFI’S
The proliferation of non-banking financial corporations ,
industrial development banks, mutual saving funds, insurance
companies, chit funds and so on have reduced the share of
commercial banks in the total credit.
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14. Underdeveloped money and capital
market
Money and capital market are less developed and
fragmented.
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15. Functions of central bank
RBI was set up in 1935
Function of Central Bank:
 It acts as the note issue agency
 It acts as the bankers’ bank
 It controls credit
 It acts as the lender of the last resort
 It manages the exchange rate
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16. Functions of Commercial Banks
 Accepting Deposits
Demand Deposits or Current Deposits
Fixed Deposits or Time Deposits
Saving Banks Deposits
Recurring Deposits
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17. Role of Commercial Banks
Promotion of Savings
Mobilization of Savings
Allocation of funds
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18. Demand for money
Transactions Motive
Precautionary motive
Speculative Motive
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19. Supply of Money
Central bank: central bank is empowered to issue currency
High power money as it is backed by supporting reserves and
its value is guaranteed by the government and it is the source
of all other forms of money.
This liability must be backed by an equal value of assets
consisting mainly gold and foreign exchange reserves
especially in terms of high power foreign currencies.
In practice , however , most countries have adopted a “
minimum reserve system”.
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20. RBI measures of money supply
RBI has been using since April 1977 the following definition
and measures of money supply:
M1= C+DD+OD
M2= M1+Saving deposits with post offices
M3=M1+ Net time deposits with the commercial banks
M4= M3 + Total deposits with post offices
Where, C=Currency held by the public , DD = net demand
deposits with banks , OD = other deposits with RBI
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