Monetary Policy and Role of RBI

 

Monetary Policy and Role of RBI

What is Monetary Policy?

Monetary policy refers to the process by which the central bank (RBI) manages money supply and interest rates in the economy to achieve macroeconomic objectives like price stability, economic growth, and employment generation.

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Objectives of Monetary Policy

1. Control inflation – Ensure prices remain stable.
2. Promote economic growth – Ensure adequate liquidity for investment.
3. Ensure financial stability – Safeguard against financial crises.
4. Manage exchange rates – Maintain external stability.

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Instruments of Monetary Policy

Quantitative Tools (Affect overall money supply)

1. Repo Rate – Interest rate at which RBI lends to commercial banks.
   • Lower repo = Cheaper loans, higher liquidity.
   • Higher repo = Costlier loans, lower liquidity.
2. Reverse Repo Rate – Rate at which RBI borrows from banks.
   • Used to absorb excess liquidity.
3. Cash Reserve Ratio (CRR) – Percentage of net demand and time liabilities (NDTL) banks must maintain with RBI.
   • Higher CRR = Lower liquidity.
4. Statutory Liquidity Ratio (SLR) – Percentage of NDTL to be held by banks in liquid assets (gold, government bonds).
   • Higher SLR = Lower lending capacity.

Qualitative Tools (Direct specific credit behaviour)

1. Selective Credit Control – RBI directs banks to limit lending to certain sectors (like speculative trades).
2. Moral Suasion – RBI advises banks to follow desired lending and investment behaviour.

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Monetary Policy Framework in India

• In 2016, India adopted Inflation Targeting under a Monetary Policy Committee (MPC) framework.
• The MPC (6 members) meets every two months to set the policy repo rate.
• Target inflation: 4% (±2%).

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Role of RBI in Monetary Management

1. Formulation of Monetary Policy – Adjust repo, CRR, SLR to manage liquidity.
2. Currency Issuance – Sole authority to print currency notes.
3. Regulation of Banks – Ensuring solvency, stability, and governance.
4. Managing Foreign Exchange Reserves – Stabilising the rupee.
5. Lender of Last Resort – Provides emergency funds to banks in crisis.

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Monetary Policy in Different Economic Situations

During Inflation

• RBI increases repo rate, CRR to reduce money supply.
• Discourages excessive borrowing and spending.

During Recession

• RBI cuts repo rate, CRR to boost liquidity.
• Encourages investment and spending.

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Statement-based MCQs

MCQ 1
Consider the following statements regarding the Monetary Policy Committee (MPC):

1. It is chaired by the Prime Minister of India.
2. Its primary objective is controlling inflation.
3. It meets at least four times a year.

Which of the statements given above is/are correct?
a) 1 and 2 only
b) 2 and 3 only
c) 1 and 3 only
d) 1, 2 and 3

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MCQ 2
Which of the following tools of monetary policy directly impacts the liquidity available with commercial banks?

1. Repo Rate
2. Cash Reserve Ratio (CRR)
3. Fiscal Deficit

Select the correct answer using the code below:
a) 1 only
b) 1 and 2 only
c) 2 and 3 only
d) 1, 2 and 3

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MCQ 3
During periods of high inflation, which of the following measures is RBI most likely to adopt?

1. Increase repo rate.
2. Decrease Cash Reserve Ratio (CRR).
3. Conduct Open Market Sales of government securities.

Select the correct answer using the code below:
a) 1 only
b) 1 and 3 only
c) 2 and 3 only
d) 1, 2 and 3

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MCQ 4
Which of the following functions is performed exclusively by the Reserve Bank of India?
a) Setting fiscal policy
b) Collecting direct taxes
c) Issuing currency notes
d) Regulating commodity prices

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MCQ 5
Which of the following is a qualitative instrument of monetary policy?
a) Repo Rate
b) Open Market Operations
c) Selective Credit Control
d) Cash Reserve Ratio (CRR)