Monetary policy: B K Reddy sir

B K REDDY SIR NEXT IAS

Quantitative instruments

•Open Market Operations, Bank Rate,

Repo Rate, Reverse Repo Rate, Cash
Reserve Ratio, Statutory Liquidity Ratio,
Marginal standing facility, and Liquidity
Adjustment Facility (LAF).
Qualitative Instruments

•direct action, change in the margin

money and moral suasion etc
With reference to the Indian economy,
consider the following: (Prelims 2015)
1. Bank rate
2. Open market operations
3. Public debt
4. Public revenue
Which of the following is/are components of Monetary Policy?
a) 1 only
b) 2, 3 and 4
c) 1 and 2
d) 1, 3 and 4
In India, which one of the following is responsible
for maintaining price stability by controlling
inflation?
(a) Department of Consumer Affairs
(b) Expenditure Management Commission
(c) Financial Stability and Development Council
(d) Reserve Bank of India
The money multiplier in an economy increases
with which one of the following? (2018)
(a) Increase in the cash reserve ratio
(b) Increase in the banking habit of the
population
(c) Increase in the statutory liquidity ratio
(d) Increase in the population of the country
Supply of money remaining the same, when there is an
increase in demand for money, there will be (Prelims
2013)
a) A fall in the level of prices
b) An increase in the rate of interest
c) A decrease in the rate of interest
d) An increase in the level of income and employment
Consider the following liquid assets (Prelims 2013)
1. Demand deposits with the banks
2. Time deposits with the banks
3. Savings deposits with the banks
4. Currency
The correct sequence of these assets in the decreasing order of liquidity is
a) 1,4,3,2
b) 4,3,2,1
c) 2,3,1,4
d) 4,1,3,2
In India, the central bank’s function as the ‘lender of last
resort’ usually refers to which of the following?
1. Lending to trade and industry bodies when they fail to
borrow from other sources
2. Providing liquidity to the banks having a temporary crisis
3. Lending to governments to finance budgetary deficits
Select the correct answer using the code given below.
(a) 1 and 2 only
(b) 2 only
(c) 2 and 3 only
(d) 3 only
What is Monetary policy?
• Monetary policy refers to the policy of the central bank with
regard to the use of monetary instruments under its control to
achieve the goals specified in the Act.

• The Reserve Bank of India (RBI) is vested with the responsibility

of conducting monetary policy.

• This responsibility is explicitly mandated under the Reserve Bank

of India Act, 1934.
Objectives of MP
Chakravarty Committee,

• price stability, economic growth,

equity, social justice, and encouraging
the growth of new financial enterprises
are some crucial roles connected to the
monetary policy of India.
Urjit Patel’s report

•inflation should be the nominal anchor for

the Monetary Policy framework, which
should be set at 4 % with + /- 2 %.
RBI
• RBI is a statutory body

• (not constitutional body)

•under the Reserve Bank of India Act, 1934.

Consider the following statements: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 public interest.
3. The Governor of the RBI draws his power from the RBI Act.

Which of the above statements are correct?

(a) 1 and 2 only
(b) 2 and 3 only
(c) 1 and 3 only
(d) 1, 2 and 3
Preamble
The Preamble of the Reserve Bank of India describes the basic
functions of the Reserve Bank as:
• "to regulate the issue of Bank notes and keeping of reserves
with a view to securing monetary stability in India and
generally to operate the currency and credit system of the
country to its advantage; to have a modern monetary policy
framework to meet the challenge of an increasingly
complex economy, to maintain price stability while keeping
in mind the objective of growth."
Ways and Means Advances(1997)
ad hoc Treasury Bills

 As per the agreement, the Central Government would meet temporary

mismatches between receipts and expenditure through Ways and Means
Advances (WMA) provided by the RBI.

The size and cost of WMA would be determined on the basis of mutual
agreement.

 Amounts drawn beyond the WMA limit would be treated as overdraft.

• RBI makes advances to State Governments to tide over
mismatches in the cash flows of their receipts and payments.

• Repayable in each case not later than three months from the
date of the making of the advance.
•Treasury bills
The RBI regulates the commercial banks in
matters of (2011)
1. Liquidity of assets
2. Branch expansion
3. Merger of banks
4. Winding-up of banks

Select the correct answer using the code given below

(a) 1 and 4
(b) 2, 3 and 4
(c) 1, 2 and 3
(d) all the above
What is Section 7?
(1) The Central Government may from time to time give
such directions to the Bank as it may, after consultation
with the Governor of the Bank, consider necessary in
the public interest.
•Section 8 -for composition of Central
Board and term of office of Directors
1 Governor + 4 Deputy Governors

 4 Directors to be nominated by the Central Government, one

from each of the four Local Boards

 10 Directors to be nominated by the Central Government

2 Government officials to be nominated by Central Government.

SECTION 45 OF RBI ACT, 1935
• Under Section 45 of Banking Regulation Act, 1949, the RBI can apply to the
Central Government for suspension of Business by a Bank and to prepare a
scheme for its revival.

• Based upon the recommendations of RBI, the Central Government then can
issue notification.

• Hence, the Government issues a notification to place a Bank under Moratorium

based upon recommendations of RBI.
No. Governors Term of office
1. Osborne Smith 1 April, 1935 – 30 June, 1937
2. James Braid Taylor 1 July, 1937 – 17 February, 1943
3. C. D. Deshmukh 11 August, 1943 – 30 June, 1949
4. Benegal Rama Rau 1 July, 1949 – 14 January, 1957
5. K. G. Ambegaonkar 14 January, 1957 – 28 February, 1957
6. H. V. R. Iyengar 1 March, 1957 – 28 February, 1962
7. P. C. Bhattacharya 1 March, 1962 – 30 June, 1967
8. L. K. Jha 1 July, 1967 – 3 May, 1970
9. B. N. Adarkar 4 May, 1970 – 15 June, 1970
10. S. Jagannathan 16 June, 1970 – 19 May, 1975
11. N. C. Sen Gupta 19 May, 1975 – 19 August, 1975
12. K. R. Puri 20 August, 1975 – 2 May, 1977
13. M. Narasimham 3 May, 1977 – 30 November, 1977
14. I. G. Patel 1 December, 1977 – 15 September, 1982
15. Manmohan Singh 16 September, 1982 – 14 January, 1985
16. Amitav Ghosh 15 January, 1985 – 4 February, 1985
17. R. N. Malhotra 4 February, 1985 – 22 December, 1990
18. S. Venkitaramanan 22 December, 1990 – 21 December, 1992
19. C. Rangarajan 22 December, 1992 – 21 November, 1997
20. Bimal Jalan 22 November, 1997 – 6 September, 2003
21. Y. V. Reddy 6 September, 2003 – 5 September, 2008
22. D. Subbarao 5 September, 2008 – 4 September, 2013
23. Raghuram Rajan 4 September, 2013 – 4 September, 2016
24. Urjit R. Patel4 September, 2016 – 10 December, 2018
25. Shaktikanta Das 11 December, 2018 – Incumbent
When the RBI reduces the Statutory Liquidity Ratio (SLR) by 50
basis points, which of the following is likely to happen? (Prelims
2015)
a) India’s GDP growth rate increases drastically.
b) Foreign Institutional Investors bring more capital into our country.
c) Scheduled Commercial banks may cut their lending rates.
d) It may drastically reduce the liquidity in the banking system.
 In the context of Indian economy, 'Open Market Operations'
refers to(2013)

(a) borrowing by scheduled banks from the RBI

(b) lending by commercial banks to industry and trade
(c) purchase and sale of government securities by the RBI
(d) None of the above
Which of the following will increase Money supply in the
economy?
1. Purchase of government securities from the public by the Central Bank
2. Deposit of currency in commercial banks by the public
3. Borrowing by the government from the Central Bank
4. Sale of government securities to the public by the Central Bank
Select the correct answer using the codes given below:
(a) 1 only
(b) 2 and 4 only
(c) 1 and 3
(d) 2, 3 and 4
• Over night repo rate(1 day)
• 7,14,21 days –term repo rate
• 1 to 3 years long term repo rate
 CRR SLR

CRR requires banks to keep a certain amount

SLR requires banks to keep a certain amount of their
1. of their aggregate deposits in cash with the
aggregate deposits in liquid assets.
RBI

Banks earn interest. This is because, under SLR

Banks do not earn any interest from the RBI requirements, banks are supposed to invest in liquid
2. in case of the cash parked with RBI under assets like central and state government
CRR requirements. securities/bonds. These bonds earn banks some
interest.
•Quantitative easing (QE) is a form of monetary
policy used by central banks as a method of
quickly increasing the domestic money supply
and spurring economic activity.
•Quantitative easing usually involves a
country's central bank purchasing longer-
term government bonds, as well as other
types of assets, such as mortgage-backed
securities (MBS).
Which of the following is correct regarding
Monetary Policy Committee? (2015)
1. It decides the RBI’s benchmark interest rates.
2. It is a 12-member body including the Governor of RBI and it is
constituted every year.
3. It functions under the chairmanship of the Union Finance Minister.

Select the correct answer using the codes given below:

a) 1 only
b) 1 and 2
c) 3 only
d) 2 and 3
What is Monetary Policy Agreement?
• In 2015 The Government of India and Reserve Bank of India signed a
Monetary Policy Framework Agreement.

• The objective of monetary policy framework is to primarily maintain

price stability while keeping in mind the objective of growth.

• As per the agreement, RBI would set the policy interest rates and
would aim to bring inflation below 6 per cent by January 2016 and
within 4 per cent with a band of (+/-) 2 per cent for 2016-17 and all
subsequent years.
• If the central bank misses the inflation target, it will send a report to the
government citing reasons and remedial actions.

• The central bank will also need to give an estimated time-period within
which it expects to return to the target level.
Significance of MPA
While the agreement gives a free hand to the RBI Governor to decide
on the monetary policy measures to achieve the inflation target

it also requires the RBI to give out to the Central Government a
report in case the target is missed for a period of time.

 Thus it is a fine balance between autonomy and accountability.

• Prompt Corrective Action Framework (PCA):
Prompt Corrective Action or PCA?
• is a framework under which banks with weak financial
metrics are put under watch by the RBI.

• RBI has issued a policy action guideline (first in December

2002, later in 2014 and last revised effective from April 1,
2017)
1. capital ratios
2. asset quality/NPA
3. profitability.
4. Debt levels
OPERATION TWIST(COVID -19)

• The Operation Twist is the special Open Market

Operations (OMOs) carried out by the RBI.

• the RBI carries out OMO sales to suck out excess

liquidity and OMO purchases to inject liquidity.
• The trilemma is an economic theory, which posits that countries may
choose from three options when making fundamental decisions about
their international monetary policy agreements.

• However, only one option of the trilemma is achievable at a given

time, as the three options of the trilemma are mutually exclusive.
Liquidity Trap?

•Liquidity trap refers to a situation where

the interest rates in an economy are at
extremely low levels, and individuals prefer
to hold their money in cash or cash
equivalent form as they are uncertain
about the performance of a nation’s
economy.
• Liquidity trap is the extreme effect of monetary policy.

• It is a situation in which the general public is prepared to hold on to

whatever amount of money is supplied, at a given rate of interest.

• They do so because of the fear of adverse events like deflation, war.

Reasons
• Deflation

• Unemployment

• Recession etc
How to Overcome a Liquidity Trap?
•expansionary fiscal policy
•MONEY

B K REDDY SIR NEXT IAS

• The Minimum Reserve System is the currency issue system followed by
the RBI at present.

• It was adopted in 1956.

• The Minimum Reserve System which requires the RBI to keep a

minimum reserve of Rs 200 crores comprising foreign currencies, gold
coin and gold bullion (minimum of Rs 115 crore in the form of gold).
MONEY

• Money is any object that is generally accepted as payment for

goods and services and repayment of debts.
 FUNCTIONS OF MONEY
• A medium of exchange: an object that is generally accepted as a form of payment.

• A unit of account: a means of keeping track of how much something is worth.

• A store of value: it can be held and exchanged later for goods and services at an
approximate value.
 LEGAL TENDER
• Cannot be refused by any citizen of the country for settlement of any kind of transaction.

• Legal tender can be either limited or unlimited.

• In India, while the coins are limited legal tender, the currency notes are unlimited legal
tender.
• Under Coinage Act, 2011, 50 paise coins can be used as the legal tender for dues up to Rs
10.

• Coins of Rs 1 and above can be used as legal tender for dues up to Rs 1000.

• While anyone cannot be forced to accept coins beyond the limits mentioned, voluntarily
accepting coins for amounts exceeding the limits mentioned above is not prohibited.
Bitcoin is not legal tender in India: finance
ministry
Which one of the following statements correctly describes the
meaning of legal tender money? (2018)

(a) The money which is tendered in courts of law to defray the fee of
legal cases
(b) The money which a creditor is under compulsion to accept in
settlement of his claims
(c) The bank money in the form of cheques, drafts, bills of exchange,
etc.
(d) The metallic money in circulation in a country
• CBDC is a digital currency backed by the Central bank of a country
and hence considered as legal tender.

• It is considered as “programmable money” since it could be used

only for selected transactions or in specific regions.

• It can be either used for transactions by people (Retail CBDC) or for

settling transactions among financial Institutions such as Banks.
• Subhash Chandra Garg Committee (2019) has
recommended a ban on private cryptocurrencies
on account of concerns such as

•volatility, instability, security risk and risk of

funding illegal activities.
advantages
Promote cashless society.
Increase in Financial Inclusion
Foster development of Fintech sector
Provide a real time picture of economic activity and hence
better GDP estimates and efficient monetary policy formulation.
Traceability of transactions would crack down on corruption
and money laundering.
Counter the monopoly of private sector issued
cryptocurrencies.
MONEY DEMAND
Money demand (also known as liquidity preference) refers to holding
money in hand for the purpose of exchange.

a) Transactions motive

b) Speculative motive

c) Precautionary motive. People often demand money as a precaution

against an uncertain future.
MONEY SUPPLY
• Money supply refers to the stock of money at a point of time in the
economy.

• It includes the currency notes and coins issued by the central bank
(RBI) as well as the stock of deposits held by public in commercial
banks.
• M1 (Narrow money)= Currency with the public+ Demand deposits
with the banking system+ Other deposits with RBI

• M2= M1+ Saving deposits of Post Offices

• M3 (Broad money)= M1+Time deposits with the banking system

• M4= M3+All deposits with Post Offices (excluding National Saving

Certificates)
Liquidity Aggregates – L1, L2, and L3
L1 – M3 + All deposits with the post office savings banks (excluding
National Savings Certificates).

L2 – L1 + Term deposits with term lending institutions and

refinancing institutions (FIs) + Term borrowing by FIs + Certificates
of deposit issued by FIs.

L3 – L2 + Public deposits of non-banking financial companies.

If you withdraw Rs. 1,00,000 in cash from your Demand Deposit
Account at your bank, the immediate effect on aggregate money
supply in the economy will be(2020)

(a) To reduce it by Rs. 1,00,000

(b) To increase it by Rs. 1,00,000
(c) To increase it by more than Rs. 1,00,000
(d) To leave it unchanged
1 …The higher the reserve ratio, the lower the potential for lending and the
lower the money multiplier

2…. Currency Deposit Ratio: The currency deposit ratio (cdr) is the ratio of
money held by the public in currency to that they hold in bank deposits.

An increase in cash deposit ratio leads to a decrease in money multiplier.

An increase in deposit rates will induce depositors to deposit more,
thereby leading to a decrease in Cash to Aggregate Deposit ratio. This will
in turn lead to a rise in Money Multiplier.
3…Banking habit of people
•The money multiplier is a mechanism in which the
banking system turns a portion of deposits into
loans, which then become deposits for other
banks, leading to a larger overall increase in the
money supply
•The Reserve Ratio is the minimum ratio or
percentage of deposits that a bank is
required to keep in its reserves as cash.
All the best

B K REDDY SIR NEXT IAS