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Meaning of Monetary policy
Monetary policy is a policy of monetary authority of a country for controlling the supply of money in an economy. It is simply the measures taken by the central bank of the nation (RBI) for attaining macroeconomic objectives like consumption, inflation, liquidity, and growth.
Monetary policy is a plan of action that is drafted and implemented by RBI for controlling macroeconomic variables like unemployment and inflation.
Various tools are used by RBI for implementing the policy which involves buying and selling of government securities, changing interest rates, and adjusting the liquidity in the economy. RBI through its monetary policy promotes economic growth by increasing liquidity and prevents inflation by decreasing the liquidity.
Monetary policy is of 2 types
- Expansionary policy
- contractionary policy
Expansionary policy is the one that fuels economic growth by increasing the money supply in the economy. It reduces the interest rates, lower bank’s reserve requirements, and buying government securities by RBI for stimulating activities of the business and lowering unemployment.
Whereas, Contractionary policy lower the rate of economic growth in the country. It reduces the money supply in circulation by raising interest rates, selling of government securities, and increasing the reserve requirements of banks.
Tools of Monetary Policy
Interest rate
Interest rate is the rate that banks charge for providing credit facilities to their customers. RBI adjusts the interest rate by changing the discount rate (Base rate).
The base rate is the rate at which RBI provides loans to commercial banks, so if this rate will increase then the interest rate charged by commercial banks from their customers will also increase as their cost of borrowing from RBI has increased.
RBI uses the interest rate for increasing and decreasing the money supply in the economy by making adjustments as per the requirements.
In the case of inflation, it raises the interest rate for bringing down the money supply and in the case of deflation, it reduces the interest rate for increasing the money supply.
Changing reserve requirements
Every bank is mandatorily required to maintain a certain portion of their funds as a reserve with them and the central bank. These reserves are termed are SLR and CRR. The central bank changes the amount of these reserves from time to time for regulating the money supply in economy. For increasing the money supply, RBI lowers the amount of reserve requirement which increases the money available with banks for carrying out their business. On the other hand, it increases the reserve requirements of banks for decreasing the money supply in the economy during times of inflation.
Open market operations
Open market operations refer to the sale and purchase of government securities by the central bank for controlling the money supply in the economy. During inflation, RBI sells off securities to commercial banks for reducing their cash holdings which will eventually decrease the money supply. Whereas, RBI purchases securities from commercial banks for raising their lending power which will help in increasing the money supply in the economy.
Recent Developments in the Monetary Policy
Recent Updation in the Monetary Policy 2020
- RBI monetary policy committee voted to keep the repo rate unchanged which will provide support to the revival of economy.
- An additional liquidity at repo rate of about Rs. 10,000 crores have been announced by RBI to NHB and NABARD. It will assist these sectors to overcome the liquidity crisis.
- RBI has raised the permissible loan to value ratio from 75% to 90% for loan approved for non-agricultural uses against the security of jewellery and gold ornaments.
- RBI has not decided not to monetize fiscal deficit.
- It has decided to perform one year and three-year repos worth 1 lakh crore which will enables banks in reducing lending rates.
- Bank deposits premium is raised from 10 paise to 12 paise for time being which do not influence the balance sheets of banks.
- A 6% growth rate is projected for GDP in range of 5.5 – 6% in H1 and 6.2% in Q3.
- Cheque Truncation system will be extended all over the India as decided by RBI which will make clearing of cheque faster.