RBI Monetary Policy: Types, Objectives, MPC, Tools

What Is Monetary Policy?

Monetary policy is a set of tools used by a country’s central bank (RBI), to regulate the overall money supply, manage inflation, promote economic growth, and achieve other economic objectives.

Central banks utilize monetary policy tools, such as interest rates and bank reserves, to control the flow of money in the economy. This affects interest rates, exchange rates, and asset prices. This differs from fiscal policy, which manages economic fluctuations through government spending and taxes. Central banks in developed nations are usually independent of the government and make monetary policy decisions on their own.

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Types of Monetary Policy

Monetary policy acts like a gas pedal for the economy. It can be:

• Expansionary: This injects more money into the system, like pressing the gas, to boost economic activity, employment, and potentially inflation.
• Contractionary: This takes money out of circulation, similar to tapping the brakes, to slow down economic growth and rein in inflation.

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Objectives of Monetary Policy in India

• Regulate money supply in the economy for growth and price stability.
• Maintain price stability (control inflation).
• Promote economic growth.
• Encourage savings and investments.
• Control business cycles (boom and depression).
• Promote employment.
• Promote exports and import substitution.
• Manage aggregate demand.
• Ensure more credit for priority sectors (agriculture, small industries, etc.).
• Regulate and expand banking.

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Monetary Policy Committee of India

• The establishment of a committee to decide on monetary policy was first proposed by the Urjit Patel Committee.
• The Reserve Bank of India Act, 1934, was amended by the Finance Act (India), 2016, to constitute the Monetary Policy Committee (MPC) of RBI.
• 6 members constitute the Monetary Policy Committee, 3 from the Reserve Bank of India (RBI), and 3 external members nominated by the government.
• The RBI Governor is the ex officio chairperson.
• Decisions are made by majority vote, the Governor has a casting vote in case of a tie.
• The Monetary Policy Committee (MPC) sets India's benchmark interest rate.
• Meetings of the Monetary Policy Committee (MPC) are held at least four times a year, with decisions published after each meeting.

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Current Composition of India's Monetary Policy Committee

The current composition of India's Monetary Policy Committee is as follows:

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Tools of Monetary Policy

The Reserve Bank of India (RBI) uses various instruments to control credit and manage liquidity in the economy. These instruments are used to fight inflation (too much money supply) or deflation (too little money supply).

Interest Rates

Repo Rate: The rate at which RBI lends to banks, impacting borrowing costs throughout the economy.

Reverse Repo Rate: The rate at which RBI absorbs money from banks, affecting how much they lend.

Liquidity Tools

Liquidity Adjustment Facility (LAF): A mechanism for banks to borrow (Repo) or lend (Reverse Repo) short-term funds from RBI.

Open Market Operations (OMOs): RBI buys or sells government bonds to influence liquidity.

Reserve Requirements

Cash Reserve Ratio (CRR): The portion of deposits banks must keep with RBI, limiting their lending capacity.

Statutory Liquidity Ratio (SLR): The portion of deposits banks must hold in safe assets like government securities.

Other Measures

Marginal Standing Facility (MSF): A tool for banks to borrow additional short-term funds from RBI at a penalty rate.

Market Stabilisation Scheme (MSS): RBI sells government securities to absorb excess liquidity in the market.

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Current rates (2024) of Monetary policy of RBI