RBI and Monetary Policy

Monetary policy refers to the credit control measures adopted by the central bank of a country.

The RBI is the main body that controls the monetary policy in India. The instruments of monetary policy helps the RBI to control the flow of money into the market as well as maintain the inflation and liquidity position in the country.

MONETARY POLICY INSTRUMENTS USED BY RBI

The various monetary policy instruments used by RBI to control the supply of money in the economy are as follows-

  1. OPEN MARKET OPERATIONS – Open market operations refer to sale and purchase of securities in the money market by the central bank of the country. In situation of inflation, RBI sells the securities in the open market which reduces the flow of money in the economy resulting in decrease in investments.

Similarly, at times of deflation RBI purchases the securities from the open market resulting in increased monetary flow in the economy .

  1. BANK RATE POLICY – One of the most effective instruments of monetary policy is the bank rate. A bank rate is the rate at which the RBI lends money to commercial banks without any security or collateral. The RBI increases the bank rate at times of inflation which increases the lending rates of commercial banks thereby controlling the flow of money in the economy.
  2. CASH RESERVE RATIO & STATUTORY LIQUIDITY RATIO – Cash Reserve Ratio (CRR) is the portion of deposits with the commercial banks that it has to deposit to the RBI. When prices rise , the RBI increases the CRR which results reduced cash reserves with commercial banks to lend to the borrowers , thereby reducing the investment & output.

Statutory Liquidity Ratio (SLR) is the percent of total deposits that the commercial banks have to keep with themselves in form of cash reserves or gold. An increase in SLR by RBI results in reduction in lending capacity of the banks which curbs the situation of inflation.

Both CRR & SLR are important monetary policy tools in the hands of RBI to control the flow of money in the economy.

  1. MORAL SUASION – This is an informal method of monetary control. Under this method RBI urges to commercial banks to help in controlling the supply of money in the economy.
  1. SELECTIVE CREDIT CONTROL – Selective credit controls are used to influence specific types of credit for particular purposes. They usually take the form of changing margin requirements to control speculative activities within the economy.

 

Thus, in a nutshell, monetary policy is the macroeconomic policy laid down by the central bank which helps it in 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.

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