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MONETARY POLICY AND FISCAL

POLICY

WHAT IS MONETARY POLICY?


Monetary policy refers to the use of
instruments under the control of the
central bank to regulate the
availability, cost and use of money
and credit

OBJECTIVES OF MONETARY
POLICY
Maintaining price stability
Ensuring adequate flow of credit to the
productive Sectors of the economy to support
economic growth
Rapid economic growth
Balance of payment equilibrium
Full employment
Equal income distribution

TYPES OF MONETARY POLICY


Expansionary policy

expansionary policy increases the total supply of


money in the economy rapidly
. Expansionary policy is traditionally used to
combat unemployment in a recession by
lowering interest rates

Contractionary Monetary Policy


It is intended to control the inflation in the country at the same time
controlling the values of other assets(to explain ex : stock values which
decreases when interest rate incr.) and avoiding other distortions.
Ex : RBI may increase the interest rates to implement this policy which
would decrease the money supply in the economy as a result of price
levels may come down.

The current RBI Policy in place to control inflation can be referred to as


Contractionary Monetary Policy.
Other types also include Inflation Targeting, Price level Targeting, Gold
Standard etc. (to explain : these are also done in the same manner above
is done, just they are the sub parts or variants of the above.)

Methods
The RBI aims to achieve its objectives of
economic growth and control of inflation
through various methods.
These methods can be grouped as:
General/ quantitative methods
Selective/ qualitative methods

Direct Instruments
Cash reserve ratio (CRR)
The money supply in the economy is influenced by CRR.
It is the ratio of a banks time and demand liabilities to be kept in reserve with
the RBI.
The RBI is authorized to vary the CRR between 3% and 15%.

Statutory liquidity ratio (SLR):


Under SLR, banks have to invest a certain percentage of its time and demand
liabilities in govt. approved securities.
The reduction in SLR enhances the liquidity of commercial banks.

Indirect Instruments
Liquidity Adjustment Facility (LAF):
Consists of daily infusion or absorption of liquidity on a
repurchase basis, through repo (liquidity injection) and
reverse repo (liquidity absorption) auction operations,
using government securities as collateral.
i.

Repo Rate:

Repo rate is the rate at which the RBI lends shot-term


money to the banks against securities. When the repo rate
increases borrowing from RBI becomes more expensive.
ii.

Reverse Repo Rate:

The rate at which RBI borrows from commercial banks.

Marginal Standing Facility (MSF):


Instituted under which scheduled commercial banks can borrow over night at their
discretion up to one per cent of their respective NDTL at 100 basis points above the repo
rate to provide a safety valve against unanticipated liquidity shocks

Bank rate:
Bank Rate is the rate at which central bank of the country (in India it is RBI) allows
finance to commercial banks.
Bank Rate is a tool, which central bank uses for short-term purposes.
Any upward revision in Bank Rate by central bank is an indication that banks should also
increase deposit rates as well as Base Rate / Benchmark Prime Lending Rate.

Market Stabilization Scheme (MSS):


Liquidity of a more enduring nature arising from large capital flows is absorbed through
sale of short-dated government securities and treasury bills.
The mobilized cash is held in a separate government account with the Reserve Bank.