Monetary Policy
Learn all about India's monetary policy. What is monetary policy? who makes it and how it influences your borrowing decisions. If you want to take a loan understand how the changes in the monetary policy affect you or work for you.
About Monetary Policy
The Monetary policy refers to a set of policies that are adopted by the Central Bank with a focus on promoting sustainable economic growth. It involves the overall management of money supply and interest rates to control several economic factors, including inflation, liquidity, consumption, and growth.
The monetary policy of the Central Bank of the Nation (RBI) refers to the use of monetary instruments to achieve certain economic goals, as per the Reserve Bank of India Act, 1934.
The major goal of the policy implemented by the central bank is to maintain neutral interest rates depending on the current social and economic factors. Monetary policies focus on balancing the monetary scale to avoid inflation and other socio-economic situations.
When the central bank increases or decreases the borrowing rates as per their policies, other financial institutes and banks also change their rates.
What is Monetary Policy?
Monetary policy is a set of tools controlled by the central bank of the country that focuses on maintaining the sustainable growth of the economy across the nation. The central bank increases and decreases the money supply that is available in the banks of the nation. The main focus is to promote economic growth by controlling the interest rates in the country.
These policies balance the overall supply of money in the country by bringing a balance to the nation's banks, and businesses in the country. All customers are rate-sensitive when it comes to borrowing loans from lenders. Irrespective of the size of businesses, they always prefer borrowing loans when the interest rates remain on the lower side. The overall borrowing of loans can be controlled by the implementation of the monetary policy by the central bank.
The policies can also change bank reverse requirements. Monetary policies can be roughly classified into two sections - contractionary and expansionary depending on their current set of rules and terms in the country.
RBI Monetary Policy
The central bank i.e. Reserve Bank of India, follows a set of policies to focus on the economic growth of the country. The goal is to take several measures to control the supply of money and the cost of credit in India.
The RBI monetary policy uses several instruments such as bank rates, credit controls, interest rates, open market rates, and currency supply.
Take a look at the chart to understand the current monetary policy rates as per the indicators of the central bank.
| Current Rate | Indicator |
|---|---|
| 18% | SLR |
| 5.65% | Bank Rate |
| 5.15% | Marginal Facility Rates |
| 6.50% | Repo Rate |
| 3.35% | Reverse Repo Rate |
| 4.50% | CRR |
These rates are calculated based on the rules set by the central bank in the country in 2021. The Indian monetary policy can change the interest rates and the supply of money in the country based on several situations.
The monetary policies focus on the availability of the overall amount in the country and the cost of credit all the time.
Objectives of Monetary Policy
The major objective of the RBI monetary policy is to focus on the overall economic growth of the country by controlling the money supply and utilization.
In order to fully understand the concept of monetary policy and how it works, you must go through the objectives of the central bank in India.
- The major objective of the policies is to maintain a balance in the production and utilization of money across the country.
- Maintaining price stability while focusing on economic growth is one of the major objectives of implementing monetary policies in the country.
- By controlling the interest rates and money supply in the country, monetary policies control the savings and investments of people.
- The government of the country sets an inflation target once every five years. The Central Bank of India has a huge role to play when it comes to inflation control in the country.
- Since the policies can control the demands in the country, it encourages monetary authorities to use these policies to maintain a balance between the supply and demand of goods. When the interest rate is low, more people take loans to buy goods and services which leads to a rise in demand.
Controlling the interest rates can bring an immense change in the utilization of money in the country. Individuals and businesses seek to borrow loans when the interest rate remains on the lower side. An increased rate maintains the monetary balance in the country well.
Types of Monetary Policies
The role of implementing the monetary policies across the country are performed by the RBI. The focus is on maintaining price stability while focusing on overall economic growth.
Three major types of policies are implemented by the Central Bank of India.
Contractionary Policy
It is one of the most influential types of monetary policy. Contractionary policies are implemented to fight and remove inflation in the country. It decreases the money supply along with raising the interest rates in the economy. Therefore, the borrowers find borrowing loans during this period created by the contractionary policy. The overall economic activity was reduced due to this situation. It can control inflation in the economy.
Expansionary Policy
Expansionary monetary policies are implemented in the country by increasing the overall money supply and decreasing interest rates in the economy. When the interest rates decrease, borrowers all over the country seek out loans which eventually increases economic activity. This situation can lead to more employment opportunities in the nation.
However, this situation can lead to inflation due to the availability of money, other services and goods in the country.
Unconventional Policy
Unconventional policies are implemented by the central bank when the primary instruments of their monetary policies stop achieving the desired results in the economy.
These are the three major types of monetary policy that are implemented by the central bank in India to control the overall monetary situation while focusing on the economic growth of the country.
Monetary Policy Tools
The monetary policy of RBI follows a set of tools to ensure the overall economy of the country remains in a balanced state.
Open Market Operations
Open market operations refer to the procedure that focuses on selling and buying government securities and treasury bills to regulate the money supply in the country.
When the government wants to decrease the money supply rates, it implements these bonds. As per the current monetary policy of India, the money is used to buy these bonds so that the internet rates in the economy increase. When the government wants to increase the money supply of the country, it sells these bonds and decreases the interest rates instantly.
Statutory Liquidity Ratio
The banks of India keep liquid assets in the texture of gold, approved securities, and cash. The reduction of the SLR, therefore, affects the overall availability of money in the country.
Cash Reserve Ratio
The CRR refers to the cash that is held by the RBI as a percentage of NDTL (Net Demand and Time Liabilities). When the CRR increases, it becomes essential for the banks in the country to keep huge portions of the deposits with the central bank.
Moral Suasion
It is another essential tool used by the monetary policy of RBI. The central bank, directly and indirectly, influences the other banks in the country to regulate the same terms of credit growth through oral and formal communication.
Selective Credit Control
By following the selective credit control method, the RBI controls the growth of the country in 2 ways:
- Regulating the credit for the consumers of the country
- Focusing on the margin requirements and increasing or decreasing the interest rates of the country.
Liquidity Adjustment Facility
The monetary policies of India use the LF to purchase money from them on certain repurchase agreements.
- Repo rates are the interest rates that are provided by the central bank to the other banks that are against the collateral of the government.
- Reverse repo rates are fixed interest rates that the central bank implements to absorb liquidity.
What is the Monetary Policy Committee?
The Monetary Policy Committee or MPC determines the interest rate policies in the country. The central government constituted the committee under section 45ZB to focus on the overall economic growth of the country while controlling the supply of money in the economy.
Monetary Policy Transmission
To fully understand what is monetary policy, one must understand how monetary policy transmission works.
It is a procedure that refers to the way the targeted policies meet the ultimate objectives and control growth and inflation in the country.
It refers to the process of how the rules and policies of the central bank are implemented in the country to meet the ultimate objectives of economic growth and inflation control. How the entire procedure takes place is called the monetary policy transmission.
Difference Between Monetary Policy & Fiscal Policy
The monetary policy mainly refers to the activities and set of rules that are implemented by the central bank of the country to focus on the overall economic growth while controlling the supply of money and inflation in the country.
On the other hand, Fiscal policy refers to the decisions taken by the government regarding taxation policies and spending.
Both the fiscal policy and the monetary policies focus on the economic growth of the country. However, the fiscal policy mainly focuses on the government's decisions regarding the taxation policies in the country. And the monetary policies focus on the overall economic growth of the country.
FAQs
The members of the Federal Open Market Committee meet around eight times per year to decide whether or not any changes will be implemented in the monetary policies of the country.
The two major types of monetary policy or expansionary monetary policy and contractionary monetary policy. The expansionary policy increases the overall money supply by decreasing the interest rates in the country. On the other hand, the contractionary policy decreases the money supply and increases the interest rates in the country.
The major factors that affect monetary policies include changes in GDP, the rate of anticipated inflation, the rate of interest in the country, for how long it is possible for one to use debit cards and credit cards, the number of monetary transactions we expect to have per year, and others.
These are the major factors that affect the Indian monetary policy.
The main purpose of monetary policy is to focus on the economy's overall growth while maintaining a good supply of money and controlling inflation in the country.
The monetary policy implemented by the country's central bank ensures economic growth and controls the money supply. Therefore, the rules and terms of these policies can affect the interest rates of the country. An increased or decreased interest rate can lead to inflation-like situations.
When the interest rates increase, inflation is controlled in the economy. Due to the unavailability of money in the country, borrowers stay away from taking out loans frequently. On the other hand, when interest rates decrease, more people take out loans.
Inflation takes place when the interest rates remain on the lower side. Unemployment is another issue that arises in this situation.
If a recession arises, the RBI uses an expansionary monetary policy. The increase in the money supply in the economy promotes the number of loans and reduces the interest rates in the country.
When the interest rates decrease, more people and businesses take out loans. Due to the over-availability of money in the country, a situation like inflation can take place.
Businesses often stay away from borrowing loans when the interest rates remain on the higher side. This contractionary method causes several developmental problems for businesses.
Monetary policies use several methods to control the economic growth of the country. While following the contractionary policy, the central bank decreases the money supply and increases interest rates in the country. On the other hand, when they follow the expansionary policy, the interest rates of the country decrease.