Monetary Policy

Monetary policy is the policy of the government which corrects the situations of excess and deficient demand by regulating interest rate and availability of credit in the economy.Interest rate is the cost of credit.The cost of credit is raised and availability of credit is reduced when excess demand is to be corrected.this is called Dear money policy.
On the other hand cost of credit is reduced and availability of credit is increased when deficient demand is to be corrected.this is called Cheap money policy.


Components of monetary policy        

              
Open Market Operations

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   An open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit. The RBI sells government securities to control the flow of credit and buys government securities to increase credit flow. Open market operation makes bank rate policy effective and maintains stability in government securities market.

Cash Reserve Ratio

Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances. Higher the CRR with the RBI lower will be the liquidity in the system and vice versa. RBI is empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by the Narsimham committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002. As of 4 October 2016, the CRR is 4.00 percent.

Statutory Liquidity Ratio

Every financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities. These assets have to be kept in non cash form such as G-secs precious metals, approved securities like bonds etc. The ratio of the liquid assets to time and demand assets is termed as the Statutory liquidity ratio.There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narsimham Committee. The current SLR is 19.50%. This will be reduced to 20% with effect from 24th June 2017 in line with the changes in RBI Credit Policy.

Bank Rate Policy

The bank rate, also known as the discount rate, is the rate of interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other approved financial institutes. Funds are provided either through lending directly or discounting or buying money market instruments like commercial bills and treasury bills. Increase in Bank Rate increases the cost of borrowing by commercial banks which results in the reduction in credit volume to the banks and hence declines the supply of money

Credit Ceiling

In this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. 

Credit Authorization Scheme

Credit Authorization Scheme was introduced in November, 1965 when P C Bhattacharya was the chairman of RBI. Under this instrument of credit regulation RBI as per the guideline authorizes the banks to advance loans to desired sectors.

Moral Suasion

Moral Suasion is just as a request by the RBI to the commercial banks to take so and so action and measures in so and so trend of the economy. RBI may request commercial banks not to give loans for unproductive purpose which does not add to economic growth but increases inflation

Repo Rate and Reverse Repo Rate

Repo rate is the rate at which RBI lends to its clients generally against government securities. Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and increase in Repo rate discourages the commercial banks to get money as the rate increases and becomes expensive. Reverse Repo rate is the rate at which RBI borrows money from the commercial banks. The increase in the Repo rate will increase the cost of borrowing and lending of the banks which will discourage the public to borrow money and will encourage them to deposit. As the rates are high the availability of credit and demand decreases resulting to decrease in inflation. This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the policy.