Topic :- monetary policy

PRESENTED BY:- POORVI PAWAR, MOKSHA KATARIA,

MANSI PAL, ISHITA SHARMA

instructor -Dr.Abhikrati Shukla

CONTENT
■ Objective
■ Outcome
■ Meaning
■ Definition
■ Objectives of monetary policy
■ Types
■ Instruments
■ Targets
■ RBI monetary policy 2021
■ Current rates
■ Conclusion
■ MCQ
OBJECTIVE
■ To understand the concept of monetary policy.
■ To develop understanding about the types of
monetary policy.
■ To develop understanding about CRR, SLR,
Bank rate, repo rate, reverse repo rate, etc.
■ To know about the RBI monetary policy 2021.
OUTCOMES
■ The learning will help to understand the
meaning and definition of monetary policy.
■ Helps to get the clear understanding of
instruments of monetary policy.
■ Provide an overview of wider scope of
monetry policy.
 WHAT IS MONETARY POLICY

■ Monetary policy is the macroeconomic policy laid down by

the central bank. It involves management of money supply
and interest rate and in the demand side economic policy
used by the government of a country to achieve
macroeconomic objectives like to control the inflation,
increasing consumption, Increasing growth and maintain
Liquidity.
■ Monetary policy refers to the credit control measures adopted
by the central bank of a country. In case of Indian economy
RBI is the sole monetary authority which decides the supply
of money in the economy.
 DEFINITION
■ Monetary policy refers to the credit
control Measures adopted by the
central bank of our country .
■ “A policy employing the central banks
control of the supply of money as an
instrument for achieving the objectives
of general economic policy is a
monetary policy”.
By Prof. Harry Johnson
OBJECTIVES OF MONETARY
POLICY
■ 1. High Employment
■ 2. Economic Growth
■ 3. Price Stability
■ 4. Interest-Rate Stability
■ 5. Stability of Financial Markets
■ 6. Stability in Foreign Exchange Markets
1. High employment –

■ When consumers spend more money, businesses

enjoy increased revenues and profits. This allows
companies to update plant and equipment assets and
to hire new employees. During a period of
expansionary monetary policy, unemployment
declines because companies find it easier to borrow
money to expand their operations.
2. Economic Growth –

■ Expansionary monetary policy spurs economic growth

during a recession. Adding money to the economic
system lowers interest rates and eases credit restrictions
that banks apply to loan applications.
3. Interest-rate stability –

■ Interest rate stability is vital as fluctuations in it will

create a lot of uncertainty in an economy. This will
make it more difficult for you to plan for the future. If
there is a lot of fluctuation in interest rates, your wish to
buy sustainable goods such as house or a car will get
affected. This will directly affect the economy in the
long run.
4. Price stability :-

■ One of the primary objective of India's monetary policy is

to maintain price stability in the economy. It controls the
inflation rate of the economy. Furthermore, the money
supply affects the price level, so monetary policy manages
the money supply to maintain price stability.
5. Stability Of financial market-

■ Monetary policy has powerful effects on financial

markets, the financial system, and the broader
economy. Conversely, financial instability, by
impairing the provision of credit and other
financial services, can depress economic growth,
cause job losses, and push inflation too low.
6. Stability in Foreign Exchange Markets -

■ When the government or Federal Reserve uses monetary

or fiscal policy to expand the economy, this increases our
income and our demand for imports, and ultimately lowers
the exchange rate. Contractionary policies have the
opposite effect. ... This decreases the demand for dollars
and decreases the exchange rate.
Types of monetary policy
CONTRACTIONARY / TIGHT MONETARY POLICY

■ Contractionary policy expands the money supply

more slowly than usual or even shrinks it.

■ Contractionary policy is intended to slow inflation in

order to avoid the resulting distortions and
deterioration of asset values.
EXPANSIONARY /EASY MONETARY
POLICY
■ Expansionary policy increases the total supply of money in
the economy more rapidly than usual.

■ Expansionary policy is traditionally used to try to combat

unemployment in a recession by lowering interest rate in the
hope that easy credit will and entice businesses into
expanding.
■ The Financial Times defines expansionary monetary
policy as "A policy by monetary authorities to expand
money supply and boost economic activity, mainly by
keeping interest rates low to encourage borrowing by
companies, individuals and banks.
EFFECT OF MONETARY POLICY

Recession
• Borrowing is difficult.
• Consumers buy less.
Inflation • Businesses postpone expansion.
• Borrowing is easy.
• Unemployment increases.
• Consumers buy more .
• Production is reduced.
• Business expand.
• More people are employed.
• People spend more.

■ LOOSE MONEY POLICY TIGHT MONEY POLICY

 INSTRUMENTS FOR MONETARY
POLICY
■ Credit control is an important tool Used by Reserve Bank of India a
major weapon of the monetary policy used to control the demand and
supply Of money in the eonomy .

1. Quantitative
1 bank rate
2 open market operation
3 Required reserve ratio
4 repo rate and reverse repo rate
5 liquidity adjustment facility
6 Marginal standing facility
2. Qualitative

1. Rationing of credit
2. Variable interest rate
3. Regulation of consumer credit
4. Moral suasion
Quantitative instruments
1 Bank Rate
■ The bank rate, also known as the discount rate is the oldest Instrument
of monetary policy.
■ Bank rate is the rate at which the central bank gives credit to the
commercial bank or A bank rate is the interest rate at which a nation’s
central bank lends money to domestic banks, often in the form of very
short-term loans.
■ Managing the bank rate is a method by which central banks affect
economic activity.
■ The central bank tries to control credit by influencing both the cost as
well as the availability of credit.
■ Two main objective of bank rate :-

1. Discount rate :- Bank can rediscount bill of

exchange and commercial papers at bank rate from
RBI.

2. Penalty rate :- incase bank default on maintaining

CRR and SLR then bank has to pay penalty to RBI
and that penalty rate decided through bank rate.
2 Open market operations
■ Open market operations are the means of implementing monetary
policy by which a central bank controls its national money supply
by buying and selling government securities or other financial
instruments.
■ Omo refers to the sale and purchase of government securities in the
open market by the central bank .
■ By selling the securities central bank withdraws cash balance from
the economy and vice versa.
■ Central Bank performs buying and selling both operations.
3. Required reserve ratio :-
■ The reserve bank also uses the method of Variable Reserve requirements
to control credit in India.
■ By changing the ratio, The reserve bank seeks to influence the credit
creation power of the commercial banks.
■ The variable reserve ratio device springs from the fact that the central in
its capacity as bankers bank. Must hold a part of Cash reserve of
commercial bank.
■ Therefore the cash reserve ratio (CRR) is raised by the central bank when
credit contraction is desired and lowered when credit is to be expanded.
■ The commercial banks are obliged to maintain cash reserve with central
banks on two account.
1. CRR 2. SLR
■ CRR (cash reserve ratio)
■ it refers to minimum percentage of Bank total deposit required to
be kept with the central bank. commercial bank have to keep with
the central bank a certain percentage of their deposit in the form of
cash reserve as a matter of law.
■ The Reserve Bank of India or RBI mandates that banks store a
proportion of their deposits in the form of cash so that the same can
be given to the bank’s customers if the need arises.
■ The percentage of cash required to be kept in reserves a bank’s total
deposits, is called the Cash Reserve Ratio. The cash reserve is either
stored in the bank’s vault or is sent to the RBI. Banks do not get any
interest on the money that is with the RBI under the CRR
requirements.
■ If the current CRR rate is 3%, a bank is required to store 3% of
the total NDTL or the Net Demand and Time Liabilities in the
form of cash. The bank cannot use this money for investment or
lending.
There are two primary purposes of the Cash Reserve Ratio:
■ Since a part of the bank’s deposits is with the Reserve Bank of
India, it ensures the security of the amount. It makes it readily
available when customers want their deposits back.
■ CRR helps in keeping inflation under control. At the time of high
inflation in the economy, RBI increases the CRR, so that banks
need to keep more money in reserves so that they have less money
to lend further.
CRR (Example)
■ SLR (statutory liquidity ratio)
■ Bank have to invest certain percentage of the deposit in specified
financial securities like Central Government or State
Government securities this percentage is known as SLR.
■ This money is predominantly invested in government approved
securities (bonds ), gold ,which mean the bank can earn some
amount as ‘ interest ‘on these investment as against CRR where
they do not earn anything.
■ Example: if the SLR is set at 20% and a banks total deposit is
1000, the bank needs to invest 200 in approved securities or
bonds.
SLR (Example)
4. Repo rate
■ Repo Rate is the rate at which banks borrow rupees from RBI.
whenever the banks have any shortage of funds they can borrow it
from RBI.
■ It is a rate at which RBI lends money to commercial bank.
■ Repo means repurchase option.
■ Repo rate refers to the rate at which commercial banks borrow money
by selling their securities to the Central bank of our country that is
Reserve Bank of India (RBI) to maintain liquidity, in case of shortage
of funds or due to some statutory measures.
■ It is one of the main tools of RBI to keep inflation under control.
■ It is always higher than reverse repo rate.
5. Reverse repo rate
Reverse repo rate is completely opposite of repo rate.
■ Reverse Repo Rate is a mechanism to absorb the liquidity in the
market, thus restricting the borrowing power of investors.
■ Reverse Repo Rate is when the RBI borrows money from banks when
there is excess liquidity in the market. The banks benefit out of it by
receiving interest for their holdings with the central bank.
■ During high levels of inflation in the economy, the RBI increases the
reverse repo. It encourages the banks to park more funds with the RBI
to earn higher returns on excess funds. Banks are left with lesser
funds to extend loans and borrowings to consumers.
6. Liquidity Adjustment Facility:
■ It is a tool, used in monetary policy, primarily by the Reserve Bank of
India (RBI) that allows banks to borrow money through repurchase
agreements. This arrangements allows bank to respond to liquidity
pressures and is used by governments to assure basic stability in the
financial markets.
■ The RBI may use the facility for adjusting liquidity to manage high
level of inflation. it does this by raising the repo rate which increase
the cost of debts servicing, Thus in Return reduces a supply of
investment and money within the economy of India.
7. Marginal Standing Facility:
■ The MSF is a window provided by the reserve bank of India (RBI) to
commercial banks to borrow funds overnight in case of emergency or
acute liquidity shortages. It allows banks to borrow funds against
government securities by paying higher interest rate than the repo
rate. This rate is typically higher to encourage banks to first explore
other avenues before resorting to the MSF.
■ The marginal standing facility is a liquidity support mechanism in the
monetary policy framework of the RBI. It was introduced in 2011 and
is designed to help banks manage their liquidity requirements
effectively.
Qualitative instruments
1. Rationing of credit
■ Credit rationing is the limiting by lenders of the supply of additional
credit to borrowers who demand funds at a set quoted rate by the
financial institution.
■ It is an example of market failure, as the price mechanism fails to bring
about equilibrium in the market. It should not be confused with cases
where credit is simply "too expensive" for some borrowers, that is,
situations where the interest rate is deemed too high.
■ With credit rationing, the borrower would like to acquire the funds at the
current rates, at the prevailing market interest rate, demand exceeds
supply, but lenders are not willing to either loan more funds, or raise the
interest rate charged, as they are already maximising profits, or are
cautious in continuing to meet their capital reserve requirements.
3. Variable interest rate
■ A variable interest rate (sometimes called an “adjustable”
or a “floating” rate) is an interest rate on a loan or
security that fluctuates over time because it is based on an
underlying benchmark interest rate or index that changes
periodically.
■ The obvious advantage of a variable interest rate is that if
the underlying interest rate or index declines, the
borrower’s interest payments also fall. Conversely, if the
underlying index rises, interest payments increase. Unlike
variable interest rates, fixed interest rates do not fluctuate.
4. Regulations of consumer credit
■ If there is excess demand for certain consumer durable
leading to their high prices Central Bank can reduce customer
credit by increasing down payment, and reducing the number
of installments of repayment of such credit.
■ consumer credit refers to loans taken by people for purchase
of goods and services RBI regulate the total volume of credit
that may be extended to customers by the commercial bank
and fixes a minimum time period for repayment or increases
down payment required for specific categories to influence the
flow of credit in a particular direction.
5. Moral Suasion
■ Moral suasion refers to the suggestions to commercial
banks from the RBI that helps in restraining credits in the
inflationary period.
■ RBI implies pressure on the Indian banking system without
taking any strict action for compliance with rules.
■ Through monetary policy, commercial banks get informed
of the expectations of RBI.
■ The RBI can issue directives, guidelines, suggestions for
commercial banks regarding reducing credit supply for
speculative purposes under the moral suasion.
 Significance of monetary policy
The following points highlight the seven main
targets of monetary policy.
1. A stable price level
2. A gently rising price level
3. A gently falling price level
4. Neutral money
5. Exchange stability
6. Avoidance of cyclical fluctuations
7. Full-employment and economic growth.
1. A stable price level:
■ A stable price level indicates a situation where the overall prices of goods
and services in an economy don't experience significant or abrupt changes
over time. In such an environment, inflation (the increase in prices) or
deflation (the decrease in prices) is minimal.
■ This stability is beneficial because it provides predictability for consumers
& businesses. Consumers can plan their spending without worrying that
their money will rapidly lose value. Businesses can make more accurate
forecasts about costs and revenues, which aids in decision-making and
investment.
■ Overall, price stability fosters a more conducive environment for economic
growth and stability.
2. A gently rising price level:
■ A gently rising price level is typically characterized by moderate inflation,
where the prices of goods and services slowly increase over time. This
gradual uptick in prices allows businesses to adjust their pricing strategies
and consumers to adapt their spending habits without experiencing sudden
shocks or significant disruptions to their purchasing power.
■ It's often seen as a sign of a stable and growing economy, as it can
encourage investment, support wage growth, and promote economic
expansion without causing excessive inflationary pressures. Central banks
often aim for this moderate inflation to maintain economic stability and
encourage sustainable growth.
3. A gently falling price level:
■ A gently falling price level, occurs when the overall prices of goods and
services in an economy decrease gradually over time. While a moderate
decrease in prices might initially seem beneficial for consumers, persistent
deflation can have various implications:
■ Impact on Spending: Consumers might delay purchases, expecting further
price drops, which can lead to decreased consumer spending. This
behavior can negatively affect businesses and economic growth.
■ Income and Wages: Falling prices can put pressure on wages and incomes,
as companies may struggle to maintain profitability. This situation can lead
to reduced wages or even job cuts, impacting overall economic stability.
4. Neutral money:
■ Neutral money refers to the concept that changes in the quantity of money
within an economy should ideally have no effect on real variables such as
employment, output, or long-term economic growth. In other words, changes
in the money supply would only affect nominal variables like prices.
5. Exchange stability:
■ Exchange stability generally refers to the condition where a country's
currency maintains a relatively constant value against other currencies over
time. It's essential for economic stability, as drastic fluctuations can impact
trade, investments, and overall economic health. Several factors contribute
to exchange stability, such as government policies, monetary reserves, trade
balances, and investor confidence. Central banks often intervene in
currency markets to stabilize exchange rates, using tools like interest rates,
currency reserves, or interventions in the foreign exchange market to
maintain stability.
6. Avoidance of cyclical fluctuations:
■ Cyclical fluctuations refer to the ups and downs in economic activity, known as economic
cycles or business cycles, which include periods of expansion, peak, contraction, and
trough.
■ To minimize these fluctuations, central banks aim to implement monetary policies that
provide stability and support sustainable economic growth.
7. Full-employment and economic growth:
■ Full Employment: This refers to a situation where nearly all individuals who are willing
and able to work can find employment. Central banks aim to support conditions conducive
to full employment through monetary policy. They often use interest rates as a tool to
influence employment levels.
■ Economic Growth: Central banks also play a role in fostering sustainable economic
growth. They use monetary policy to manage inflation and promote stability, which are
crucial for fostering an environment conducive to long-term growth. By setting
appropriate interest rates and influencing the money supply, central banks aim to support
economic expansion while ensuring that growth is not excessively rapid and doesn't lead
to harmful levels of inflation.
Full forms
■ CPI = consumer price index .
■ MSF = Marginal standing facility .
■ TLTRO = targeted long term repo operation.
■ NEFT = National electronic funds transfer.
■ RTGS = Real time gross settlement.
■ MSS = Market stabilizing scheme.
■ CRR = Cash reserve ratio.
■ SLR = Statutory liquidity ratio.
■ GDP = gross domestic product.
CONCLUSION
■ After discussing all those things we can say
monetary policy is a process by which the
Monetary Authority of a country control the
supply of money ,often targeting the rate of
interest for the purpose of promoting
economic growth and stability.
 Multiple choice questions
1. Bank rate is the rate at which the Reserve Bank of India
provides loans to

a) Public sector undertakings

b) Commercial banks
c) Private corporate sector
d) Non-banking financial institution
Answer :- b

– Commercial banks
2. When the supply for money increases and the
demand for money reduces, there will be

a) A fall in the level of prices

b) A decrease in the rate of interest
c) An increase in the rate of interest
d) A fall in the level of demand
Answer :- b

– A decrease in the rate of interest

3. If the interest rate decreases in an economy, it will
a) Decrease the investment expenditure in the economy
b) Increase the loan repayment by the government
c) Increase the consumption expenditure in the economy
d) Increase the total savings in the economy
Answer :- C

– Increase the consumption

expenditure in the economy.
4. The cost of bank credit is determined on the basis
of base rate and all bank loans are given at a rate
equal to or higher than the base rate. Of the following,
who determines this base rate?

a) It is fixed by the Reserve Bank of India

b) It is determined by the Ministry of Finance
c) It is determined by market forces of supply and demand for
credit.
d) It is determined by the bank concerned
Answer :- d

– It is determined by the bank

Concerned.
5. When the Reserve Bank of India announces an
increase in the cash reserve ratio, what does it mean?
a) The commercial banks will have less money to lend.
b) The union government will have less money to lend.
c) The union government will have more money to lend.
d) The commercial banks will have more money to lend.
Answer :- a

– The commercial banks will have less

money to lend.
6. Which one of the following is not an instrument of
selective credit control in India?
a) Regulation of consumer credit
b) Rationing of credit
c) Margin requirement
d) Reserve ratios
Answer :- d

– Reserve Ratios
7. Which agency has the foremost role in regulation of
banking sector in India?
a) Reserve Bank of India
b) Union Finance Commission
c) Union Ministry of Finance
d) Union Ministry of Commerce
Answer :- a

– Reserve Bank of India

8. Which of the following guidelines by the RBI does
not hamper the profitability of commercial banks in
India?
a) Cash reserve ratio
b) Statutory liquidity ratio
c) Margin requirements
d) Bank rate
Answer :- d

– Bank Rate
9. The banks are required to maintain a certain ratio
between their liquid assets and total deposits. This
ratio is called
a) CRR (cash reserve ratio)
b) SLR (statutory liquidity ratio)
c) CAR (capital adequacy ratio)
d) CLR (central liquid reserve)
Answer :- b

– SLR( statutory liquidity ratio)

11. The accounting year of the Reserve Bank of India is
a) April-March
b) July-June
c) October-September
d) January-December
Answer :- b

– July June
12. What is “monetary base”?
a) The cash issued under the authority of the central
bank
b) The money whose real value exceeds its nominal
value
c) The currency with public and deposits maintained
by the commercial banks with the Reserve Bank of
India
d) None of the above
Answer :- c

– The currency with public and deposits

maintained by the commercial banks
with the Reserve Bank of India
13. Which of the following is not included in the
reserve money?
a) Currency in circulation
b) Banker’s deposits with the RBI
c) Government deposits with the RBI
d) Demand deposit with banks
Answer :- d

– Demand deposit with banks

14. What is bank rate?
a) Rate on deposits given by commercial banks
b) Rate charged by banks on loans and advances
c) Rate payable on bonds
d) Rate at which the Reserve Bank of India discounts the bills
of exchange
Answer :- d

– Rate at which the Reserve

Bank of India discounts the
bills of exchange
15. Sterilization by the RBI is carried through:
a) Open market operation
b) Reduction in bank rate
c) Deficit financing operation
d) Reduction in statutory liquidity ratio
Answer :- a

– Open Market Operation