Monetary Policy

The Monetary policy refers to a set of policies that are adopted by the Central Bank with a focus on promoting sustainable economic growth. It involves the overall management of money supply and interest rates to control several economic factors, including inflation, liquidity, consumption, and growth.

The monetary policy of the central bank of the nation (RBI) refers to the use of monetary instruments to achieve certain economic goals, as per the Reserve Bank of India Act, 1934.

The major goal of the policy implemented by the central bank is to maintain neutral interest rates depending on the current social and economic factors. Monetary policies focus on balancing the monetary scale to avoid inflation and other socio-economic situations.

When the central bank increases or decreases the borrowing rates as per their policies, other financial institutes and banks also change their rates.

Monetary policy is a set of tools controlled by the central bank of the country that focuses on maintaining a sustainable growth of the economy across the nation. The central bank increases and decreases the money supply that is available in the banks of the nation. The main focus is to promote economic growth by controlling the interest rates in the country.

These policies balance the overall supply of money in the country by bringing a balance to the nation's banks, businesses in the country. All customers are rate-sensitive when it comes to borrowing loans from lenders. Irrespective of the size of businesses, they always prefer borrowing loans when the interest rates remain on the lower side. The overall borrowing of loans can be controlled by the implementation of the monetary policy by the central bank.

The policies can also change bank reverse requirements. Monetary policies can be roughly classified into two sections - contractionary and expansionary depending on their current set of rules and terms in the country.

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The central bank i.e Reserve Bank of India, follows a set of policies to focus on the economic growth of the country. The goal is to take several measures to control the supply of money and the cost of credit in India.

The RBI monetary policy uses several instruments such as bank rates, credit controls, interest rates, open market rates, and currency supply.

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Take a look at the chart to understand the current monetary policy rates as per the indicators of the central bank.

These rates are calculated based on the rules set by the central bank in the country in 2021. The Indian monetary policy can change the interest rates and the supply of money in the country based on several situations. 

The monetary policies focus on the availability of the overall amount in the country and the cost of credit all the time.

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The major objective of the RBI monetary policy is to focus on the overall economic growth of the country by controlling the money supply and utilization.

In order to fully understand the concept of monetary policy and how they work, you must go through the objectives of the central bank in India.

• The major objective of the policies is to maintain a balance in the production and utilization of money across the country.
• Maintaining price stability while focusing on economic growth is one of the major objectives of implementing monetary policies in the country.
• By controlling the interest rates and money supply in the country, monetary policies control the savings and investments of people.
• The government of the country sets an inflation target once every five years. The central bank of India has a huge role to play when it comes to inflation control in the country.
• Since the policies can control the demands in the country, it encourages monetary authorities to use these policies to maintain a balance between the supply and demands of goods. When the interest rate is low, more people take loans to buy goods and services which leads to a rise in demands.

Controlling the interest rates can bring an immense change in the utilization of money in the country. Individuals and businesses seek to borrow loans when the interest rate remains on the lower side. An increased rate maintains the monetary balance in the country well.

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The role of implementing the monetary policies across the country are performed by the RBI. The focus is on maintaining price stability while focusing on overall economic growth.

There are three major types of policies that are implemented by the central bank of India.

Contractionary policy

It is one of the most influential types of monetary policy. Contractionary policies are implemented in order to fight and remove inflation in the country. It decreases the money supply along with raising the interest rates in the economy. Therefore, the borrowers find borrowing loans during this period created by the contractionary policy. The overall economic activity reduces due to this situation. It can control inflation in the economy.

Expansionary policy

Expansionary monetary policies are implemented in the country by increasing the overall money supply and decreasing interest rates in the economy. When the interest rates decrease, borrowers all over the country seek out loans which eventually increases economic activity. This situation can lead to more employment opportunities in the nation.

However, this situation can lead to inflation due to the availability of money, other services and goods in the country.

Unconventional policy

Unconventional policies are implemented by the central bank when the primary instruments of their monetary policies stop achieving the desired results in the economy.

These are the three major types of monetary policy that are implemented by the central bank in India to control the overall monetary situation while focusing on the economic growth of the country.

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The monetary policy of RBI follows a set of tools to ensure the overall economy of the country remains in a balanced state.

Open Market Operations

Open market operations refer to the procedure that focuses on selling and buying government securities and treasury bills to regulate the money supply in the country.

When the government wants to decrease the money supply rates, it implements these bonds. As per the current monetary policy of India, the money is used to buy these bonds so that the internet rates in the economy increase. When the government wants to increase the money supply of the country, they sell these bonds and decrease the interest rates instantly.

Statutory Liquidity Ratio

The banks of India keep liquid assets in the texture of gold, approved securities and cash. The reduction of the SLR, therefore, affects the overall availability of money in the country.

Cash Reserve Ratio

The CRR refers to the cash that is held by the RBI as a percentage of NDTL (Net Demand and Time Liabilities). When the CRR increases, it becomes essential for the banks in the country to keep huge portions of the deposits with the central bank.

Moral Suasion

It is another essential tool used by the monetary policy of RBI. The central bank, directly and indirectly, influences the other banks in the country to regulate the same terms of credit growth through oral and formal communication.

Selective Credit Control 

By following the selective credit control method, the RBI controls the growth of the country in 2 ways:

1. Regulating the credit for the consumers of the country 
2. Focusing on the margin requirements and increasing or decreasing the interest rates of the country.

Liquidity Adjustment Facility

The monetary policies of India use the LF to purchase money from them on certain repurchase agreements.

1. Repo rates are the interest rates that are provided by the central bank to the other banks that are against the collateral of the government.
2. Reverse repo rates are fixed interest rates that the central bank implements to absorb liquidity.

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The monetary policy committee or MPC determines the interest rate policies in the country. The central government constituted the committee under section 45ZB  to focus on the overall economic growth of the country while controlling the supply of money in the economy.

In order to fully understand what is monetary policy, one must understand how monetary policy transmission works.

It is a procedure that refers to the way the targeted policies meet the ultimate objectives and control growth and inflation in the country.

It refers to the process of how the rules and policies of the central bank are implemented in the country to meet the ultimate objectives of economic growth and inflation control. The way in which the entire procedure takes place is called the monetary policy transmission.

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The monetary policy mainly refers to the activities and set of rules that are implemented by the central bank of the country to focus on the overall economic growth while controlling the supply of money and inflation in the country.

On the other hand, Fiscal policy refers to the decisions taken by the government regarding taxation policies and spending.

Both the fiscal policy and the monetary policies focus on the economic growth of the country. However, the fiscal policy mainly focuses on the government's decisions regarding the taxation policies in the country. And the monetary policies focus on the overall economic growth of the country.

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