Q. How does a central bank control its money supply?

RBI controls money supply in the market through various tools and measures.
1.CRR - Cash Reserve Ratio is the proportion of total deposits that the banks are
required to maintain with the RBI has reserves. By changing this ratio RBI can influence
the amount of cash that is available for the banks to lend. A high CRR implies less money
to lend, thus contraction in money supply. A low CRR enables banks to hold more cash
with them, which is then available to lend. Thus, expanding the money supply.
2.Open Market Operation - It is the sale/purchase of the government bonds and
securities in the market to adjust the rupee liquidity. For example, when RBI sells
government bonds/securities, people buy them against money (say cash) this leads to a
contraction in money supply as money moves from public to RBI. In case of purchases,
money supply expands.
3.Repo Rate - It is the rate at which the central bank (RBI) lends money to commercial
banks. If RBI increases this repo rate, it becomes costlier for the commercial banks to
borrow money from RBI. They are left with lesser amount of money to lend to the
general public. Thus the money supply contracts. A low repo rate helps commercial bank
avail loans at cheaper prices, thus expanding the money supply.
4.When inflation is high, RBI increases interest rate so in this way money supply
decreases. So in this way people take less money from bank.
When inflation is low, RBI decreases interest rate so as to increase money supply in
market.
So, by controlling Interest rate RBI control money supply in market. So as to prevent
conditions of Hyper-Inflation of Hyper-Deflation.

Q. Monetary policy transmission in India?

In the Indian scenario, the momentary policy transmission is heavily depending upon
the repo rate. The repo rate is the anchor rate in determining the interest rate in the
economy (of the banking system). Now, how far a change in repo rate can bring a
corresponding change in interest rate by banks depends upon the financial conditions of
the banking system as well. In this respect, the banking system holds the center stage in
Indias monetary policy transmission.

Q. Evaluation of the latest monetary policy in India.

1.Repo (Repurchase) rate also known as the benchmark interest rate is the rate at which
the RBI lends money to the banks for a short term. When the repo rate increases,
borrowing from RBI becomes more expensive. If RBI wants to make it more expensive
for the banks to borrow money, it increases the repo rate similarly, if it wants to make it
cheaper for banks to borrow money it reduces the repo rate.
2. CRR - Cash Reserve Ratio - Banks in India are required to hold a certain proportion of
their deposits in the form of cash. However, Banks don't hold these as cash with
themselves, they deposit such cash with Reserve Bank of India, which is considered as
equivalent to holding cash with themselves. This minimum ratio (that is the part of the
total deposits to be held as cash) is stipulated by the RBI and is known as the CRR or
Cash Reserve Ratio.
3. SLR - Statutory Liquidity Ratio - Every bank is required to maintain at the close of
business every day, a minimum proportion of their Net Demand and Time Liabilities as
liquid assets in the form of cash, gold and un-encumbered approved securities. The ratio
of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio (SLR).
RBI is empowered to increase this ratio up to 40%. An increase in SLR also restricts the
bank's leverage position to pump more money into the economy.
4. Bank Rate - This is the long term rate (Repo rate is for short term) at which central
bank (RBI) lends money to other banks or financial institutions. Bank rate is not used by
RBI for monetary management now. It is now same as the MSF rate. Current bank rate is
7%.
5. Call Rate - Inter bank borrowing rate - Interest Rate paid by the banks for lending and
borrowing funds with maturity period ranging from one day to 14 days. Call money
market deals with extremely short term lending between banks themselves. After
Lehman Brothers went bankrupt Call Rate sky rocketed to such an insane level that
banks stopped lending to other banks.
Current RBI Monetary Policy Rates
6.50%
Repo Rate
Bank Rate

7.00%

Marginal Standing Facility (MSF)

7.00%

Cash Reserve Ratio (CRR)

4.00%

Statutory Liquidity Ratio (SLR)

21.00%