What is the Monetary Policy?

The Monetary and Credit Policy is the policy

statement, traditionally announced twice a
year, through which the Reserve Bank of
India seeks to ensure price stability for the
economy.
• RBI through this policy controls the
factors which include - money supply,
interest rates and the inflation. In banking
and economic terms money supply is
referred to as M3 - which indicates the
level (stock) of legal currency in the
economy.
• Besides, the RBI also announces norms
for the banking and financial sector and
the institutions which are governed by it.
When is the Monetary Policy announced?

Historically, the Monetary Policy is

announced twice a year - a slack season
policy (April-September) and a busy
season policy (October-March) in
accordance with agricultural cycles.
These cycles also coincide with the
halves of the financial year.
 How is the Monetary Policy different from the
Fiscal Policy?
• Two important tools of macroeconomic policy
are Monetary Policy and Fiscal Policy.
• The Monetary Policy regulates the supply of
money and the cost and availability of credit in
the economy. It deals with both the lending
and borrowing rates of interest for commercial
banks.
• The Monetary Policy aims to maintain price
stability, full employment and economic
growth.
• The Reserve Bank of India is responsible for
formulating and implementing Monetary
Policy. It can increase or decrease the supply
of currency as well as interest rate, carry out
open market operations, control credit and
vary the reserve requirements.
• The Monetary Policy is different from
Fiscal Policy as the former brings
about a change in the economy by
changing money supply and interest
rate, whereas fiscal policy is a broader
tool with the government.
• The Fiscal Policy can be used to
overcome recession and control
inflation. It may be defined as a
deliberate change in government
revenue and expenditure to influence
the level of national output and prices.
• For instance, at the time of recession the
government can increase expenditures or
cut taxes in order to generate demand.
• On the other hand, the government can
reduce its expenditures or raise taxes
during inflationary times. Fiscal policy aims
at changing aggregate demand by suitable
changes in government spending and
taxes.
• The annual Union Budget showcases the
government's Fiscal Policy.
 What are the objectives of the Monetary
Policy?
• The objectives are to maintain price stability
and ensure adequate flow of credit to the
productive sectors of the economy.
• Stability for the national currency (after looking
at prevailing economic conditions), growth in
employment and income are also looked into.
The monetary policy affects the real sector
through long and variable periods while the
financial markets are also impacted through
short-term implications.
• All this is more linked to the banking
sector. How does the Monetary Policy
impact the individual?
• In recent years, the policy had gained in
importance due to announcements in the
interest rates.
• Earlier, depending on the rates
announced by the RBI, the interest costs
of banks would immediately either
increase or decrease.
• What do the terms CRR and SLR
mean?
• CRR, or cash reserve ratio, refers to a
portion of deposits (as cash) which banks
have to keep/maintain with the RBI. This
serves two purposes. It ensures that a
portion of bank deposits is totally risk-free
and secondly it enables that RBI control
liquidity in the system, and thereby,
inflation.
• Besides the CRR, banks are required to invest
a portion of their deposits in government
securities as a part of their statutory liquidity
ratio (SLR) requirements.
• The government securities (also known as gilt-
edged securities or gilts) are bonds issued by
the Central government to meet its revenue
requirements. Although the bonds are long-
term in nature, they are liquid as they can be
traded in the secondary market.
• How does the Monetary Policy affect the
domestic industry and exporters in particular?
• Exporters look forward to the monetary policy
since the central bank always makes an
announcement on export refinance, or the rate
at which the RBI will lend to banks which have
advanced pre-shipment credit to exporters.
• A lowering of these rates would mean lower
borrowing costs for the exporter.
• The stock markets and money move
similarly, in some ways. Why?

• Most people attribute the link between

the amount of money in the economy
and movements in stock markets to the
amount of liquidity in the system. This
is not entirely true.
• Is the money supply related to jobs,
wages and output?
• At any point of time, the price level in
the economy is determined by the
amount of money floating around. An
increase in the money supply -
currency with the public, demand
deposits and time deposits - increases
prices all round because there is more
currency moving towards the same
goods and services.
• Some Monetary Policy terms:
• Bank Rate
• Bank rate is the minimum rate at which the
central bank provides loans to the
commercial banks. It is also called the
discount rate.
• Usually, an increase in bank rate results in
commercial banks increasing their lending
rates. Changes in bank rate affect credit
creation by banks through altering the cost
of credit.
• Cash Reserve Ratio

• All commercial banks are required to keep

a certain amount of its deposits in cash with
RBI. This percentage is called the cash
reserve ratio. The current CRR requirement
is 8 per cent.
• Inflation
• Inflation refers to a persistent rise in prices.
Simply put, it is a situation of too much
money and too few goods. Thus, due to
scarcity of goods and the presence of
many buyers, the prices are pushed up.
• Money Supply (M3)
• This refers to the total volume of money
circulating in the economy, and
conventionally comprises currency with
the public and demand deposits (current
account + savings account) with the
public.
• Statutory Liquidity Ratio
• Banks in India are required to maintain 25
per cent of their demand and time
liabilities in government securities and
certain approved securities.
• These are collectively known as SLR
securities.
 To Conclude
• The objectives of the Monetary Policy
are to maintain price stability and
ensure adequate flow of credit to the
productive sectors of the economy.
• Stability for the national currency (after
looking at prevailing economic
conditions), growth in employment and
income are also looked into.
• RBI takes various measures to ensure
above objectives