MONTEREY POLICY COMMITTEE
1. Context
2. About Monetary Policy Committee
- The Monetary Policy Committee (MPC) is a key decision-making body within a central bank responsible for formulating and implementing monetary policy.
- Its primary objective is to ensure price stability and support sustainable economic growth.
- The committee achieves this by setting policy interest rates and employing other monetary tools to influence various aspects of the economy.
2.1. Types of Monetary Policy
Monetary policy is a dynamic toolset employed by central banks to regulate economic activity and maintain stability. These policies can be broadly classified into two distinct approaches: expansionary and contractionary policies.
Expansionary Policy: Expansionary policy serves as a catalyst for invigorating economic activity, particularly in times of sluggish growth or recessions. This policy endeavours to bolster economic momentum by amplifying the total money supply within the economy. The augmentation of the money supply is achieved by reducing prevailing interest rates on loans and various forms of debt.
Contractionary Policy: Contractionary policy is an essential countermeasure aimed at curbing excessive inflation driven by a surplus money supply. This strategy involves a deliberate reduction in the aggregate money supply within the economy, predominantly through interest rate escalation.
2.2. Key features of the Monetary Policy Committee
Composition: The MPC was constituted in 2016 as part of the RBI's reforms to its monetary policy framework. The MPC is composed of six members:
- The Governor of the RBI (Chairperson)
- Two Deputy Governors
- Three external members appointed by the government
Interest Rate Decisions: One of the main functions of the MPC is to set the policy interest rates, such as the repo rate or the official cash rate. These rates influence borrowing costs for banks and, subsequently, impact lending rates throughout the economy.
Inflation Targeting: Many central banks adopt an inflation-targeting framework. The MPC sets a target range for the inflation rate and adjusts policy rates to achieve this target. This approach helps anchor inflation expectations and maintain price stability.
Economic Analysis: The MPC analyzes a wide range of economic indicators, including inflation trends, GDP growth, unemployment rates, consumer spending, and global economic conditions. This analysis informs the committee's decisions on monetary policy adjustments.
2.3. Instruments of monetary policy
Repo Rate: The Repo Rate stands as the fixed interest rate at which the RBI extends overnight liquidity to banks against approved collateral (government securities) within the Liquidity Adjustment Facility (LAF).
Reverse Repo Rate: The Reverse Repo Rate, conversely, is the fixed interest rate at which the RBI withdraws liquidity from banks overnight by accepting eligible government securities under the LAF.
Liquidity Adjustment Facility (LAF): Comprising both overnight and term repo auctions, the LAF dynamically infuses liquidity. The RBI progressively enhances liquidity via variable rate repo auctions of diverse tenures. Term repos fortify the inter-bank term money market, fostering market-driven benchmarks for lending and deposit rates.
Marginal Standing Facility (MSF): The MSF extends an additional overnight borrowing avenue to scheduled commercial banks, leveraging a portion of their Statutory Liquidity Ratio (SLR) portfolio. This safeguard helps buffer the banking system against unforeseen liquidity shocks.
Corridor: The daily fluctuation range in the weighted average call money rate is dictated by the interplay between the MSF rate and the reverse repo rate.
Bank Rate: The Bank Rate presides over the rate at which the RBI purchases or rediscounts commercial papers. It's synchronized with the MSF rate, automatically adapting to changes in the policy repo rate.
Cash Reserve Ratio (CRR): Mandating banks to maintain a prescribed fraction of their Net Demand and Time Liabilities (NDTL) as a daily average balance with the RBI, the CRR curates liquidity in the banking system.
Statutory Liquidity Ratio (SLR): A percentage of NDTL that banks must hold in liquid assets, such as government securities, cash, and gold, constitutes the SLR. SLR adjustments wield a pivotal role in regulating lending resources for the private sector.
Open Market Operations (OMOs): OMOs orchestrate the outright purchase and sale of government securities, strategically infusing or withdrawing long-term liquidity.
Market Stabilisation Scheme (MSS): Introduced in 2004, the MSS adroitly manages surplus liquidity resulting from capital inflows. By vending short-term government securities and treasury bills, the RBI expertly absorbs longer-term surpluses.
3. About Monetary Policy Framework
- A Monetary Policy Framework is a set of principles, strategies, and tools that a central bank uses to manage and control the money supply and interest rates in an economy to achieve specific economic goals.
- The primary objective of most monetary policy frameworks is to promote price stability and sustainable economic growth.
- Central banks play a crucial role in a country's economy by influencing the availability of money and credit, which in turn affects spending, investment, and overall economic activity.
- A well-defined monetary policy framework helps guide the central bank's actions and decisions to achieve its objectives.
3. About Marginal Standing Facility
- The Marginal Standing Facility (MSF) is a special window provided by the central bank of a country to its commercial banks for borrowing funds on an overnight basis.
- The MSF is typically designed to serve as a mechanism for banks to obtain emergency or additional liquidity when they are unable to meet their short-term funding requirements through other means.
4. Difference between Repo Rate and Interest Rate
4.1. Repo rate
- The repo rate is the rate at which the central bank (in India, the Reserve Bank of India or RBI) lends money to commercial banks.
- It is a short-term rate, meaning that the money is borrowed and repaid overnight.
- The repo rate is used to control the liquidity in the banking system.
- When the repo rate is low, it encourages banks to lend money, which increases liquidity.
- When the repo rate is high, it discourages banks from lending money, which decreases liquidity.
4.2. Interest rate
- The interest rate is the rate at which banks charge their customers for loans.
- It is a long-term rate, meaning that the loan is repaid over months or years.
- The interest rate is influenced by several factors, including the repo rate, the inflation rate, and the risk of default.
| Feature | Repo rate | Interest rate |
| Definition | The rate at which the central bank lends money to commercial banks |
The rate at which banks charge their customers for loans
|
| Maturity | Short-term (overnight) | Long-term (months or years) |
| Purpose | To control liquidity in the banking system | To earn a profit for banks and to cover the cost of lending money |
| Influences | Inflation rate, risk of default, and repo rate | Inflation rate, risk of default, and repo rate |
|
For Prelims: RBI, Monetary Policy Committee, Inflation, Interest Rates, Repo rate, Marginal Standing Facility, Monetary Policy Framework,
For Mains:
1. What is the key difference between the repo rate and the interest rate? Explain how these rates impact different aspects of the economy. (250 Words)
|
|
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)
1. Bank rate
2. Open Market Operations
3. Public debt
4. Public revenue
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 5. With reference to inflation in India, which of the following statements is correct? (UPSC 2015)
A. Controlling the inflation in India is the responsibility of the Government of India only
B. The Reserve Bank of India has no role in controlling the inflation
C. Decreased money circulation helps in controlling the inflation
D. Increased money circulation helps in controlling the inflation
Answer: C
6. With reference to India, consider the following statements: (UPSC 2010)
1. The Wholesale Price Index (WPI) in India is available on a monthly basis only.
2. As compared to Consumer Price Index for Industrial Workers (CPI(IW)), the WPI gives less weight to food articles.
Which of the statements given above is/are correct?
A. 1 only B. 2 only C. Both 1 and 2 D. Neither 1 nor 2
Answer: C
7. Consider the following statements: (UPSC 2020)
1. The weightage of food in Consumer Price Index (CPI) is higher than that in Wholesale Price Index (WPI).
2. The WPI does not capture changes in the prices of services, which CPI does.
3. Reserve Bank of India has now adopted WPI as its key measure of inflation and to decide on changing the key policy rates.
Which of the statements given above is/are correct?
A. 1 and 2 only B. 2 only C. 3 only D. 1, 2 and 3
Answer: A
8. If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do? (2020) (1) Cut and optimize the Statutory Liquidity Ratio (2) Increase the Marginal Standing Facility Rate (3) Cut the Bank Rate and Repo Rate Select the correct answer using the code given below: A. 1 and 2 only B. 2 only C. 1 and 3 only D. 1, 2 and 3
Answer: B
|
