MONETARY POLICY

INTRODUCTION
 Purpose of Monetary Policy
• Monetary policy is all about Stabilizing the
volatile prices
• Price volatility is one of the challenges faced
by most of the countries in the world.
• In order to arrest the price fluctuations in the
system the economic policies like monetary
policy are used
 Monetary Policy
• The role of the central bank of any country is
decisive in the socio-economic front to ensure
price stability which is caused by :
inflation
Deflation

Price stability is the pre-requisite condition for

sustaining long term economic growth
 Monetary Policy
• The MP mechanism ,headed by the central
bank of any country , is the way in which
changes in the money supply affect the rest of
the economy.
• Good banking structure with strong central
bank is essential to :
- control inflation and deflation and
- maintain financial conditions for
sustaining growth
 What is Monetary Policy?
It is the process by which :
The monetary authority of a country controls
the supply of money
By targeting a rate of interest for the purpose
of promoting economic growth and stability.
 Goals of MP
• Stabilize the prices and
• Reduce the unemployment levels
 Types of MP
• Expansionary Monetary Policy
• Contractionary Monetary Policy
 Expansionary Monetary Policy

• When an economy adopts such MP, It’s focus

is to increase the total supply of money in an
economy faster than usual.
• EMP is used to combat unemployment in a
recession by lowering interest rates in the
hope that easy credit will entice businesses
into expand operations and provide more
employment.
 Contractionary Monetary Policy

• When an economy adopts such a MP, it’s focus is

to decrease the total supply of money in an
economy
• CMP is used when there is too much money
supply in the economy.
• Too much money supply increases the problem of
inflation
• In order to reduce inflationary impact central
bank increases interest rates in the hope that
credit will become difficult and money supply will
reduce.
Monetary Policy –Role of central
bank
 Functions of Central Bank
• Custody and management of foreign exchange
reserves
• Acting as a bank to the Banker
• Acting as a banker to the Government
• Central bank as the Lender of the Last Resort
• Central bank as the controller of credit
Central bank as the controller of credit

• The central bank of a country exercises

discretionary control over the monetary
system of the country
• It commands an important structure of the
country
Central bank as the controller of credit
• From all functions mentioned in the previous
slide , control of credit is the most important.
• The Central bank’s function of control of credit is
essential for economic stability and orderly
growth of an economy.
• The Reserve Bank of India announces the
Monetary Policy six times a year.
• This policy determines the supply of money in the
economy and the rate of interest charged by
banks
• The policy is also contains an economic overview
and future forecasts.
Central bank as the controller of credit

The instruments of Monetary Policy are:

• Quantitative
• qualitative
 Quantitative Instruments
• Bank rate
• Statutory Liquidity Ratio
• Cash Reserve Ratio
• Repo Rate
• Reverse Repo Rate
• Open Market Operations
 Qualitative Instruments
• Margin Requirements
• Consumer credit regulation and guidelines
• Moral suasion
• Direct Action
 Bank Rate
• It is also known as Discount Rate
• Bank Rate is used as a signal by the RBI to the
commercial banks on RBI’s thinking of what
the interest rates should be.
 Objective of bank rate
• When RBI increases the bank rate , the cost of
borrowing for banks rises
• This credit volume gets reduced leading to
decline in supply of money
• Thus , increases in banks rate reflects
tightening of RBI monetary policy.
 Repo Rate
• Or Repurchase rate , is the rate at which RBI
lends to banks for short periods.
• This is done by RBI buying government bonds
from banks with an agreement to sell them
back at a fixed rate.
 Objective of Repo Rate
• To inject liquidity in the system
• In case RBI wants to make it expensive for
banks to borrow money , it increases the repo
rate
• Similarly , if banks want to make it cheaper for
banks to borrow money, it reduces the Repo
Rate.
 Difference between Bank Rate and
Repo Rate
• Often seems Bank Rate and Repo Rate similar
because in both of them RBI is lending to the
banks.
• But Repo Rate is a short-term measure and it
refers to short-term loans and used for
controlling the amount of money in the market.
• Bank rate is a long-term measure and is governed
by the long-term monetary policies of the RBI.
 Conclusion
• Bank Rate is the rate of interest which a
Central Bank charges on the loans and
advances that it extends to :
* commercial banks and
* Other financial Intermediaries
RBI uses this tools to control the money supply.
 MONETARY POLICY

Reverse Repo Rate and OMO’s

 Reverse Repo Rate
• It is the rate of interest at which the RBI
borrows funds from other banks in the short
term .
• This is done by RBI selling:
*government
*securities
• To banks with the commitment to buy them
back at a future date.
 Reverse Repo Rate
• The banks use the reverse repo facility to
deposit their short-term excess funds with the
RBI and earn interest on it.
• RBI can reduce liquidity in the banking system
by increasing the rate at which it borrows
from banks.
 How does Reverse Repo Rate work?
• Hiking the repo and reverse repo rate ends up
reducing the liquidity and pushes up interest
rates
• When RBI increases the Reverse Repo , it means
that now the RBI will provide extra interest on the
money which it borrows from the banks. An
increase in reverse repo rate means that banks
earn higher returns by leading to RBI .This
indicates a hike in the deposit rate.
 Open Market Operations
• When there is excess of liquidity
• RBI resorts to sale of G-secs
• To suck out rupee from system
 Open Market Operations
• On the other hand , when there is a liquidity
crunch in the economy
• RBI buys securities from the market ,
• In order to release liquidity
• Hence, OMO can be defined as to purchase
and sale of the Government securities (G-secs)
by RBI from / to market .
 Objective of OMO
• OMOs are carried out to adjust the liquidity
condition of rupee in the economy.
• When RBI sells government securities in the
markets , the banks purchase them.
• As soon as the banks purchase government
securities , they have reduced money to lend
to the industrial houses or other commercial
sectors.
 Objective of OMO
• This reduced surplus cash , contracts the
rupee liquidity and consequently credit
creation / credit supply.
• Alternatively ,when RBI purchases the
securities , the commercial banks find them
with more surplus cash and this creates more
credit in the system.
 Conclusion
• Hence , in case of excess liquidity , RBI resorts
to sales of G-secs to suck out rupee from
system
• When there is a liquidity crunch in the
economy , RBI buys securities from the market
, thereby releasing liquidity