RBI and Fiscal – Monetary Polices

shape Description

Monetary policy defines the actions taken by the central bank(RBI) for managing economic growth and inflation. Monetary policy is maintained through actions such as increasing the interest rate, or changing the amount of money banks need to keep in the vault.

shape Concepts

Preamble to RBI act, 1934 defines objectives “to regulate the issue of bank notes and keeping the reserves with a view to securing monetary stability in india and generally to operate the currency and credit system of the country to its advantage”.

The main objectives of monetary policy:
Monetary policy is basically the management of money supply and interest rates in the economy by the Central Bank of a nation to achieve the defines set of aims. it does so by targeting the money demand by playing with interest rates.

  • To maintain price stability.
  • To ensure adequate flow of credit to productive sectors so as to assist growth.
  • Arrangment of full employment.
  • Equitable distribution of Credit.
  • Promotion of fixed deposit.
  • Expansion of credit facility.
  • Equality and Justice stability in exchange rate.

RBI uses the following tools to regulate the monetary policy.

they are

  • Bank Rate
  • Statutory Liquidity Ratio
  • Cash Reserve Ratio
  • Open Market Operations

Bank Rate:

  • Rate at which RBI extends credit to commercial banks.
  • Also called discount rate.
  • It is a potent tool to control inflation.
  • An increase in Bank Rate is a disincentive for banks to borrow, threreby reducing the money supply.

Cash Reserve Ratio:

  • Cash Reserve Ratio is the specified minimum fraction of customer deposits held by commercial banks with RBI.
  • It is to ensure the banks do not run out of money and meet demands of all depositors.
  • It is effective in controlling money supply.

Statutory Liquidity Ratio:

  • It is the reserve requirement which the commercial banks in india are required maintain as liquid assets like cash,gold,government securities etc.
  • The recommendations of the Narasimhan Committee brought it down to 25% from 40% in 1997.

Open Market Operations:

  • Purchase and sale of government securities(G-Secs) by RBI from market to maintain money supply. This is undertaken by market stabilization schemes MSS and liquidity Adjustment facility LAF.
  • RBI sell Banks Purchase Reduces excess reserves with banks Contract Money/ Credit supply.

Liquidity Adjustment Facility:

  • Liquidity Corridor.
  • Difference between Repo rate and Reserve Repo rate.
  • Reserve Rate: Banks borrow from RBI with G-Secs as Collateral.
  • Reserve Repo Rate: RBI borrows from banks by lending G-Secs.
  • Both rates are decided by RBI.

Marginal Standing Facility:

  • Created by RBI in 2011 to adjust liquidity.
  • Rate at which banks borrow overnight funds from RBI against G-Secs.
  • Created to contain situations when inter bank liquidity completely dries up and interest rates are highly volatile.
  • Rate of borrowing is higher than Repo Rate.

Monetary stance:
RBI which functions as the monetary authority of india takes the monetary policy stance by assessing the macroeconomic and financial conditions prevailing in the country by factoring in the future risks and precautions.


shape Model Questions

1. RBI stands for?
A. Reserve Bank of India
B. Rural bank of India
C. Rajastan bank of India
D. None of the Above
Answer-A
2. What defines the actions taken by the central bank(RBI) for managing economic growth and inflation?
A. Interest Rate
B. Monetary policy
C. Bank Rate
D. Cash Reserve Ratio
Answer-B
3. Bank Rate also called?
A. Interest Rate
B. Investment Rate
C. Discount Rate
D. Increase rate
Answer-C
4. The specified minimum fraction of customer deposits held by commercial banks with RBI is called?
A. Monetary Policy
B. Bank Rate
C. Statutory Liquidity Ratio
D. Cash Reserve Ratio
Answer-D
5. In which year the recommendations of the Narasimhan Committee brought it down to 25% from 40%?
A. 1997
B. 1998
C. 1999
D. 2000
Answer-A
6. Purchase and sale of government securities(G-Secs) by RBI from market to maintain money supply is called?
A. Bank Rate
B. Open Market Operations
C. Cash Reserve Ratio
D. Monetary Policy
Answer-B
7. In which year Marginal Standing Facility created by RBI?
A. 2005
B. 2010
C. 2011
D. 2012
Answer-C
8. Reserve Rate is called?
A. Both rates are decided by RBI
B. Liquidity Corridor
C. RBI borrows from banks by lending G-Secs
D. Banks borrow from RBI with G-Secs as Collateral
Answer-D
9. Reserve Repo Rate is called?
A. RBI borrows from banks by lending G-Secs
B. Banks borrow from RBI with G-Secs as Collateral
C. Liquidity Corridor
D. Both rates are decided by RBI
Answer-A
10. Open Market Operations is under taken by?
A. MSS (market stabilization schemes )
B. LAF (liquidity Adjustment facility)
C. Statutory Liquidity Ratio
D. MSS & LAF
Answer-D