Monetary Policy Notes | EduRev

Economy Traditional for UPSC (Civil Services) Prelims

UPSC : Monetary Policy Notes | EduRev

The document Monetary Policy Notes | EduRev is a part of the UPSC Course Economy Traditional for UPSC (Civil Services) Prelims.
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MONETARY POLICY
It is a macroeconomic policy tool in which the central bank (RBI) regulates the money supply and interest rates to control inflation, boost growth and stabilise currency.

Monetary policy is the process of managing a nations’ money supply to achieve specific goals - such as controlling inflation, achieving full employment etc.

TYPES OF MONETARY POLICY
(a) Expansionary: Increases the total supply of money in the economy by relaxing interest rates (cheap money).
(b) Contractionary: Reduces the money supply by increasing interest rates (dear money).
Monetary Policy Notes | EduRev

Monetary Policy Notes | EduRev
MONETARY POLICY TOOLS
To achieve the goals of monetary policy the following 2 types of tools are available to the RBI
1. Quantitative: It includes repo, reverse repo,open market operations , CRR and SLR.
(i) CRR: It is the portion of bank deposits that a bank should keep with the RBI in the form of cash.
(ii) SLR: It is the portion of time(fixed deposits) and demand(saving and current account)deposits of the banks that it should keep in the form of RBI approved liquid assets like cash, gold and government securities.

Monetary Policy Notes | EduRev(iii) Repo rate: It is the rate at which RBI lends to the banks or injects money . It is used as the policy rate.
(iv) Reverse repo: It is the rate at which RBI borrows from the banks or sucks out excess money.

2. Qualitative Tools: These include Moral suasion, credit control and direct action.
Monetary Policy Notes | EduRev

(i) Credit rationing: A maximum limit to loans and advances to a particular sector is set by RBI.
(ii) Moral suasion: Is an informal tool to persuade banks to adopt a certain behavior, to lower interest rates or to lend to small businesses . It is moral encouragement.
(iii) Direct control: The RBI here takes control of the functioning of the bank and sets parameters of business itself.


DEVELOPMENT OF INDIAN BANKING
(i) In order to make the Reserve Bank of India more powerful, the Indian Government nationalised it on January 1,1949.
(ii) With a view to have the co-ordinated regulation of Indian banking, the Indian Banking Act was passed in March 1949.
(iii) According to this Act, the Reserve Bank of India was granted extended powers for the inspection of non-scheduled banks.
(iv) For the development of the banking facilities in the rural areas the Imperial Bank of India was partially nationalised on July 1, 1955 and it was named as the State Bank of India.
(v) Other 8 banks were converted as its associate banks which form what is named as the State Bank Group.
(vi) After one decade, on April 15, 1980, those 6 private sector banks whose reserves were more than Rs. 200 crore each were nationalised.

RESERVE BANK OF INDIA

  • It is the Central Bank of the country.
  • The Reserve Bank of India was established in 1935 with a capital of Rs. 5 crore.
  • This capital of Rs. 5 crore was divided into 5 lakh equity shares of Rs. 100 each.
  • In the beginning the ownership of almost all the share capital was with the non-government shareholders.
  • In order to prevent the centralisation of the equity shares in the hands of a few people, the Reserve Bank of India was nationalised on January 1,1949.
  • The general administration and direction of RBI is managed by a Central Board of Directors consisting of 20 members which includes one Governor, four Deputy Governors, 1 Government official appointed by the Union Government of India to give representation to important stratas in economic life of the country.
  • Besides, four directors are nominated by the Union Government to represent local boards.
  • Apart from the central board there are four local boards also an d their head offices are situated in Mumbai, Chennai, Kolkata and New Delhi.
  • Five members of local boards are appointed by the Union Government for a period of four years.
  • The local boards work according to the instructions and orders given by the Central Board of Directors, and from time to time they also tender useful advice on important matter.
  • The head office of Reserve Bank of India is in Mumbai.


FUNCTIONS OF THE RBI

  • Banker to Government: It acts as an agent and adviser of central and state governments
  • Banker’s Bank: By providing the facility of opening accounts for banks, it acts as a common banker
  • Lender of Last Resort: It rescues banks that face liquidity problems to protect the interests of the depositors
  • Controller of Credit
  • Debt Manager of The Government
  • Custodian of Foreign Reserves.


MONETARY POLICY COMMITTEE
Monetary Policy Notes | EduRevIt was set up in 2016 after the Monetary Policy Framework Agreement which made inflation targeting a legal responsibility of RBI.

It amended the RBI act,1934.

It was recommended by the Urijit Patel committee in 2014.

Composition: 3 members from RBI (Governor -who acts as the ex-officio chairman, RBI deputy governor, one official nominated by the RBI board) and 3 independent members to be selected by the government.

Functions of the MPC

  • To control the inflation targets at 4 percent(give or take 2 percent)in the medium term( inflation target set by central government).
  • Decide the changes to the policy rate(repo rate) to contain the inflation within the target level
  • The RBI has to publish a Monetary policy report every six months.

IMPORTANT DEFINITIONS

  • Quantitative easing - It involves printing fresh currency to overcome debt . Lending is made easier . May lead to Inflation.
  • Liquidity trap - It is a situation when lowering interest rates does not revive demand and growth.It happens during recession.
  • Money supply - It indicates the total value of monetary assets available in an economy at a given point of time.
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