It is a process by which the monetary authority of a country
controls the supply of money, often targeting a rate
of interest for the purpose of promoting economic growth and
SCOPE Of MONETARY POLICY
Level of Monetization of the economy
Level of Development of the Financial Market
Money as Medium of exchange.
Monetary policy works by changing supply of and demand for
money and general price level.
Effecting economic activities– Production, consumption, savings
Influences all economic variables– GDP, I-S, Employment, Price
Level, Foreign Trade and BOP
Monetary Policy affects economic activity through changes in
Financial transactions are routed through the banks and
Some instruments like (Bank Rate and CRR) work through
FORMS OF MONETARY POLICY
Expansionary policy :
Policy makers use this policy to increase the money supply in
the system by lowering the interests rates.
Here the cost of money is made dearer by increasing the rate of
interest which in turn helps in reducing the money in the
system and combat inflation.
Cash Reserve Ratio (CRR)
Statutory Liquidity Ratio
Open Market Operations (OMO)
The Repo Rate
It is the rate at which the Central Bank (RBI) lends
money to the commercial bank.
Rediscounts the bills of exchange presented by the
-> Current Bank rate in India is 6%
CASH RESERVE RATIO
It is the percentage of total deposit in which Commercial
Banks are required to maintain in the form of cash reserves.
When the RBI feels that the money supply is increasing and
causing an upward pressure on inflation, the RBI has the option
of increasing the CRR thereby reducing the deposits available
with banks to make loans and hence reducing the money
supply and inflation.
Current CRR rate = 6.0%
RBI imposed SLR to control and regulate the credit creation by
the banks for the private sector and the availability of finance
to the Government.
The RBI can increase the SLR rate to absorb the excess money
in the economy, to contain inflation in favor of the consumers
Under SLR scheme the commercial banks are required by
statute to maintain a certain percentage of there daily demand
and timed deposits in the form of liquid assets(excess
reserves)– unencumbered government securities.
Current SLR rate = 24%
Repo rate is the rate at which our banks borrow rupees from
Whenever the banks have any shortage of funds they can
borrow it from RBI.
Here, there is a sale of security to RBI on an agreement to “
Repurchase” it at a future date at predetermined price.
Current Repo Rate = 8.0%
REVERSE REPO RATE
The rate at which RBI borrows money from the Banks(or
banks lend money to RBI).
RBI uses this tool when it feels that there is too much money
floating in the banking system.
Current Reverse Repo Rate : 7%
SELECTIVE CREDIT CONTROL
They lead to expansion or to contraction of the total credit as
intended by the monetary authorities.
Common Selective Controls are:
Change in Lending Margins
It refers to the situation where lenders limit the supply of
additional credit to borrowers who demand funds, even if the
latter are willing to pay higher interest rates.
Generally two measures are adopted:
Imposition of upper limits on the credit available to well
developed industries and large scale firms.
Charging a higher or progressive interest rate on bank loans
beyond a certain limit.
CHANGE IN LENDING MARGINS
It is the gap between the value of the mortgaged property and
the amount advanced.
RBI increases lending margins to decrease bank credit.
It is a method of persuading and convincing the commercial
banks to advance credit in accordance with the directives of the
central bank in overall economic interest of the country.
The central bank also writes letters and hold meetings with the
banks on money and credit matters.
It is used as a last resort in case other methods prove
In this method the monetary authorities with clear directive to
carry out their lending activity in a specified manner.
LIMITATIONS OF MONETARY
1. Time Lag:
It is referred to as the time taken in chalking the policy action
its implementation and response time.
2 types :
Out side lag
2. Problems in Forecasting :
For the formulation of monetary policy the magnitude of the
problem i.e. inflation or recession should be properly assessed
for determining the appropriate policy.
The low degree of reliability of forecasting , prediction of the
out come of a policy action and formulation of appropriate
monetary policy has remained an extremely difficult task.