INSTRUMENTS OF MONETARY POLICY
Monetary policy involves the management of a nation's money supply and interest rates to achieve economic goals. Central banks typically utilize several instruments to implement and regulate monetary policy. Here are some key instruments:
-
Open Market Operations (OMO): Central banks buy or sell government securities in the open market to influence the money supply. Purchasing securities injects money into the economy, while selling them withdraws money, impacting interest rates.
-
Interest Rates: Central banks set benchmark interest rates, like the federal funds rate in the U.S. or the repo rate in India. Altering these rates influences borrowing costs, affecting consumer spending, investment, and inflation.
-
Reserve Requirements: Central banks establish the percentage of deposits banks must hold as reserves. Lowering reserve requirements increases the amount banks can lend, boosting the money supply, while raising them restricts lending.
-
Discount Window Lending: Banks can borrow funds directly from the central bank at the discount rate. By adjusting this rate, the central bank can encourage or discourage banks from borrowing, impacting the money supply.
-
Forward Guidance: Central banks communicate future monetary policy intentions to influence market expectations. Clarity on future interest rate moves can impact investor and consumer behavior.
-
Quantitative Easing (QE): In extraordinary circumstances, central banks may implement QE, buying long-term securities and assets to inject liquidity into the economy when standard measures are insufficient.
-
Currency Pegging: Some countries peg their currency to a foreign currency or a basket of currencies. The central bank manages the exchange rate by buying or selling its currency in the foreign exchange market to maintain the peg.
These instruments offer central banks various tools to influence economic conditions, manage inflation, stimulate growth, or stabilize financial markets. The choice and combination of these tools depend on the prevailing economic conditions and the central bank's objectives
Previous Year Questions
|
1. Consider the following statements: (UPSC 2021)
1. The Governor of the Reserve Bank of India (RBI) is appointed by the Central Government.
2. Certain provisions in the Constitution of India give the Central Government the right to issue directions to the RBI in the public interest.
3. The Governor of the RBI draws his natural power from the RBI Act.
Which of the above statements is/are correct?
A. 1 and 2 only B. 2 and 3 only C. 1 and 3 only D. 1, 2 and 3
Answer: C
2. Concerning the Indian economy, consider the following: (UPSC 2015)
Which of the above is/are component(s) of Monetary Policy? (a) 1 only (b) 2, 3 and 4 (c) 1 and 2 (d) 1, 3 and 4 Answer: C 3. An increase in Bank Rate generally indicates: (UPSC 2013) (a) Market rate of interest is likely to fall. (b) Central bank is no longer making loans to commercial banks. (c) Central bank is following an easy money policy. (d) Central bank is following a tight money policy. Answer: (d) 4. Which of the following statements is/are correct regarding the Monetary Policy Committee (MPC)? (UPSC 2017) 1. It decides the RBI's benchmark interest rates. 2. It is a 12-member body including the Governor of RBI and is reconstituted every year. 3. It functions under the chairmanship of the Union Finance Minister. Select the correct answer using the code given below: A. 1 only B. 1 and 2 only C. 3 only D. 2 and 3 only Answer: A |
