Instruments of Monetary Policy
Monetary policy is a policy that is an action taken by the Central Bank regarding the activities related in monetary terms. They might be cash, credit, ledgers, mortgage, bonds, debentures, loans, check money markets, etc. The policy is designed by the Central Bank of that particular Nation to regulate the economic imbalances either may be inflation or deflation.
We will know about the monetary policy in this section in detail.
What are the basic aims of monetary policy?
The basic aim of the monetary policy are as follows:
To regulate inflation.
To decrease the level of unemployment.
To increase long term interest rates.
Tools of Monetary Policy in India
The Central bank designed the tools of monetary policy. Several central banks will create a common three tools for monetary policy irrespective of the nation. So the basic tools of monetary policy in India are:
Discount Rates
The discount rate is one of the basic terms of monetary policy. The monetary policy aims to stabilize and regulate the nation's economy, which can be fulfilled by a change in discount rates. If the discount rate is reduced, the investors can get less money and take loans from other Banks. It helps any increase in the liquidity of cash. It creates growth in the economy. If the discount rate is high, all the procedures are vice versa.
Requirement of Reserves
Every nation has to maintain some reserves of all kinds of resources, especially financial resources. To maintain these reserves, the government should understand the basic requirements of that particular country. 10 to these results are certain portions of the available funds or investments to the reserve bank. As a result, the Bank of India holds a specific part of the existing money in the form of cash. It is used to lend its customers and also for businesses. It keeps reserves from the deposits and provides them in the form of loans. It also earns some money which may help to maintain the necessities of the Central Bank and the subsidiary Banks.
Growth in Open Market Operations
We all know that a market is a place where we can buy and sell goods. Here the open market refers to the buying and selling of securities from various countries. This is another tool of monetary policy that is designed for trading activity, and it is directed and regulated by the various countries of central banks of that particular Nation with which we make a deal.
What are the Instruments of Monetary Policy?
Instruments of monetary policy in India are categorized into two types. One is qualitative, and the other one is quantitative instruments. These are designed based on the toons of monetary policy which is prescribed by The Reserve Bank of India. Instruments of monetary and credit control will act as an excellent weapon for the country to regulate the demand and supply of resources to that particular nation. So, they have designed these instruments.
Qualitative Instruments
Credit Rationing
Licensing
Requirement of margins
Dynamic interest rates
The consumer rate is to be regulated
Quantitative Instruments
Open market operations
Bank rates
Repo rates and reverse repo rates
Liquidity
Change in requirement
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Who Controls the Monetary Policy in India?
The Reserve Bank of India controls the monetary policy in India. Because it is the central bank of our nation. The instruments of the monetary policy of the RBI, which we have discussed above, can help the RBI to control the money supply and the flow of money to various activities of the nation.
RBI is the central body of India which was established in 1935.it takes care of all the financial transactions and regulates the currency of the country. It provides a set of tools and instruments to maintain monetary policy transparently.
How does the RBI Control the Money Supply in the Economy?
The main objective of the hardware is to control the money supply in the economy to maintain its stability because the Nations should stand properly only with efficient resources. The RBI uses different tools and instruments like cash reserve ratio, statutory liquidity ratio, changes in repo rate and reverse report, moral suasion, etc. several instruments are in the tools used to maintain the monetary policy.
Objectives of Monetary Policy
Bank Credit Expansion
One of the most important functions Of RBI is to control the bank credit expansion and supply of money. And special attention is paid to seasonal credit requirements without affecting the stability.
Stability of Price
Bringing in Price stability also promotes the development of the country’s economy. However, the central focus must facilitate an environment favorable to architecture. This helps the development projects to run smoothly without affecting the price stability.
Fixed Investment
The main aim here is to increase the productivity of investment without affecting non-essential fixed investment.
Distribution of Credit
Monetary authorities hold rights over decisions for assigning credits to sectors and borrowers. This policy is decided over a specified percentage in order to allocate to desired people
Promote Efficiency
The central bank pays attention to efficiency to incorporate structural changes. These structural changes include interest rates, operation constraints, and new money market instruments.
Reduce Rigidity
Reducing rigidity helps to provide considerable autonomy and a sense of flexibility at work. This helps to bring in a competitive environment and diversification among work cultures. Moreover, control over the financial system is maintained and prudence in systems is observed.
Inventories
Overloading stocks and products getting expired often results in the sickness of organizational units. And hence to avoid these habits, the monetary authority restricts forming inventories by giving a major highlight to prevent idle money in the market.
Monetary Policy Operations
Monetary policy is managed by the Central Bank Of the country. In the case of India, it is managed by the Reserve Bank of India. The operations that come under this policy are as follows:
Money Supply
Stability of price
Interest rate
Financial stability
Balance of payment
Stable exchange rate
Key Indicators of Monetary Policy
There are various factors associated with monetary policy. Though it is managed by the Reserve Bank of India it overall affects the country and its economy. According to 2020 report following are the key indicator of the monetary policy:
Monetary Policy Committee
For any organizational work, a good committee is an important requirement. And when it comes to the committee for monetary policy the following people are selected at some specific designations
Governor of Reserve Bank of India as chairperson
The deputy governor of the Reserve Bank of India as in charge of monetary policy
One officer from the Reserve Bank of India
Actions of renowned person experts in their own field such as professor research Senior Advisors or committee members.
The primary job of this committee is to observe and manage the daily liquidity work so that the target decides which weighted average Call money rate or WACR is observed.
The Monetary Policy Framework
The reserve bank of India holds full rights to manage and control the monetary policy framework for the county.
The framework aims to provide the following:
Deciding repo policy rate based on the assessment of situations
Modulating liquidity conditions to anchor money market
And once, this repo rate is announced, the RBI authority manages day to day appropriate actions with an aim to operate the target.
This framework is tuned and revised accordingly by looking at the market prospectus.
Conclusion
Hunts it is clear that the monetary policy is a proforma or a set of rules imposed by The Reserve bank of India to maintain stability in the growth of the economy. The RBI needs to monitor all the financial transactions in all its forms and to keep up the sufficiency of currency without degrading its value.
FAQs on Instruments of Monetary Policy and the Role of RBI
1. What are the primary instruments of monetary policy used by the RBI?
The Reserve Bank of India (RBI) uses two main categories of instruments to implement its monetary policy. These are designed to regulate the money supply, credit availability, and interest rate levels in the economy.
- Quantitative Instruments: These are general tools that affect the total volume of credit in the economy. They include the Repo Rate, Reverse Repo Rate, Bank Rate, Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), and Open Market Operations (OMOs).
- Qualitative Instruments: These are selective tools that target the use of credit for specific sectors or purposes. They include setting margin requirements, credit rationing, and using moral suasion.
2. How does the Reserve Bank of India (RBI) fulfil its role in managing the country's monetary policy?
The RBI manages India's monetary policy with the primary objective of maintaining price stability while keeping in mind the goal of economic growth. Its role involves several key functions:
- Formulating Policy: The RBI's Monetary Policy Committee (MPC) formulates the policy stance, deciding on key rates like the Repo Rate.
- Controlling Credit: It uses its instruments (like CRR, SLR, OMOs) to control the amount of money commercial banks can lend, thereby influencing the overall money supply.
- Managing Liquidity: Through tools like the Repo Rate and Reverse Repo Rate, the RBI injects or absorbs liquidity from the banking system to keep money market rates stable.
- Acting as a Banker's Bank: It oversees the functioning of commercial banks and acts as the lender of last resort, ensuring financial stability.
3. What is the difference between quantitative and qualitative instruments of monetary policy?
Quantitative and qualitative instruments differ in their scope and application. Quantitative instruments are general in nature and are designed to control the total volume of credit in the economy. They affect all sectors without discrimination. For example, changing the Repo Rate impacts the cost of funds for all banks. In contrast, qualitative instruments are selective. They are used to regulate the flow of credit to specific sectors or for particular purposes. For example, the RBI might use moral suasion to persuade banks to increase lending to the agricultural sector.
4. How does adjusting the Repo Rate help the RBI control inflation?
The Repo Rate is the rate at which the RBI lends money to commercial banks. It is a powerful tool to control inflation. Here’s how it works:
- To combat high inflation, the RBI increases the Repo Rate. This makes borrowing from the RBI more expensive for commercial banks.
- Commercial banks, in turn, increase their own lending rates for businesses and consumers.
- Higher interest rates discourage borrowing and spending, which reduces the overall demand for goods and services.
- This reduction in aggregate demand helps to bring down the inflation rate, making it an example of a contractionary monetary policy.
5. What are the main objectives of monetary policy in India as per the CBSE 2025-26 syllabus?
The primary objectives of the RBI's monetary policy are multifaceted, aiming for overall economic stability. The key goals are:
- Price Stability: This is the foremost objective. Controlling inflation ensures that the purchasing power of the currency remains stable, which is crucial for sustainable economic growth.
- Economic Growth: The policy aims to ensure an adequate flow of credit to productive sectors of the economy to support investment and growth.
- Financial Stability: By regulating banks and managing liquidity, the RBI works to prevent systemic risks and maintain a stable and efficient financial system.
- Exchange Rate Stability: The RBI also intervenes in the foreign exchange market to manage volatility and ensure stability in the external value of the rupee.
6. Can you explain the difference between the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR)?
Both CRR and SLR are reserve requirements for commercial banks, but they differ in form and purpose.
- Cash Reserve Ratio (CRR): This is the percentage of a bank's total deposits that it must maintain with the RBI in the form of cash. The bank earns no interest on this money. CRR is primarily used to control liquidity.
- Statutory Liquidity Ratio (SLR): This is the percentage of a bank's deposits that it must maintain in the form of safe and liquid assets, such as government securities (g-secs), gold, and cash. Banks can earn interest on these assets. SLR ensures the solvency of banks and creates a captive market for government securities.
Essentially, CRR is held as cash with the RBI, while SLR is held by the bank itself in the form of liquid assets.
7. What is the importance of Open Market Operations (OMOs) as a monetary policy tool?
Open Market Operations (OMOs) are a highly effective and flexible tool for managing liquidity in the economy. Their importance lies in their direct impact on the money supply:
- To absorb excess liquidity (and control inflation): The RBI sells government securities in the open market. This takes money out of the banking system, reducing the lending capacity of banks.
- To inject liquidity (and stimulate growth): The RBI buys government securities. This releases money into the banking system, increasing the funds available for lending.
OMOs are important because they allow the RBI to make day-to-day adjustments to liquidity conditions without changing key policy rates like the Repo Rate.
8. How does an 'expansionary' monetary policy differ from a 'contractionary' one?
An expansionary policy aims to increase the money supply, while a contractionary policy aims to decrease it.
- Expansionary Monetary Policy: Also known as 'easy money policy', it is used to combat recession or economic slowdowns. The RBI will lower interest rates (like the Repo Rate) and reduce reserve requirements (CRR/SLR) to encourage borrowing, spending, and investment.
- Contractionary Monetary Policy: Also known as 'tight money policy', it is used to control inflation. The RBI will raise interest rates and increase reserve requirements to discourage borrowing and reduce the money supply in the economy.
9. Why is maintaining monetary stability considered a crucial role for the RBI?
Maintaining monetary stability is crucial because it creates a predictable economic environment, which is essential for long-term growth. When there is stability:
- Inflation is controlled: This protects the savings of households and maintains their purchasing power. It prevents the arbitrary redistribution of wealth that high inflation causes.
- Investment is encouraged: Businesses can make long-term investment decisions with confidence, as they are not worried about high and volatile inflation or interest rates.
- Financial System is sound: A stable environment prevents bank failures and financial crises, ensuring that the system of credit and payments functions smoothly.
Without monetary stability, economic planning becomes difficult for individuals, businesses, and the government, leading to uncertainty and slower economic progress.
10. What is 'moral suasion' and how does it work as a qualitative instrument of credit control?
Moral suasion is a qualitative, or selective, credit control instrument used by the RBI. It does not involve legal action but relies on persuasion, advice, and requests from the RBI to commercial banks. It works by:
- The RBI issuing directives or guidelines to banks to either restrict or expand credit for specific purposes.
- For example, during an inflationary period, the RBI might persuade banks to be more cautious in lending for speculative activities.
- Conversely, it might encourage banks to increase lending to priority sectors like agriculture or small-scale industries to promote economic growth.
It is a psychological tool that relies on the RBI's authority and its close working relationship with commercial banks to achieve policy objectives without using forceful measures.
