Introductory Macroeconomics

Book: Introductory Macroeconomics

Chapter: 3. Money And Banking

Subject: Social Science - Class 12th

Q. No. 12 of Exercises

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What are the instruments of monetary policy of RBI? How does RBI stabilize money supply against exogenous shocks?

The monetary policy or credit policy of RBI involves two instruments qualitative and quantitative. Both of them are being discussed below –

1) Quantitative measures include –

i) Bank Rate: Bank rate is the rate at which Central Bank (RBI) provides loan to the commercial bank. The RBI controls money supply through bank rate in given manner - Increasing the bank rate will make loans expensive for commercial banks and therefore they will increase the rate of lending and the public capacity to take credit will fall and vice-versa.

ii) Open Market Operations (OMO): Open market operation means buying and selling securities in open market so as to affect the supply of money in the economy the selling of securities by RBI will wipe out extra cash balance on economy and therefore the money supply will be Limited whereas buying securities by RBI will pump additional money in the economy and the money supply will increase.

iii) Variable Reserve Ratios: The Reserve Bank uses two types of reserve ratio to regulate the money supply – the Statutory Liquidity Ratio (SLR) and the Cash Reserve Ratio (CRR). SLR refers to the minimum percentage of assets to be maintained with RBI are there in fixed or liquid form. If SLR is increased the credit flow will reduce and vice a versa. CRR refers to the minimum amount of fund that has to be maintained by commercial bank with RBI in form of deposit. If CRR will be increased then the commercial banks will have less money to lend and thus the money supply will decrease and vice-a-versa.

2) Qualitative measures include –

i) Margin Requirements: Commercial banks grant loan on the basis of the value of security being mortgage, so the banks keep a margin which is the difference between market value of the security mortgaged and the loan value. If the Central Bank decides to restrict flow of money it raises the margin requirement of loan and vice versa.

ii) Selective credit control: Selective credit control: It is an instrument of monetary policy that affects the flow of credit to a particular sector positively and negatively. The positive aspect is concerned with increased flow of credit to the priority sector whereas negative aspect is to restrict credit to a particular sector.

iii) Moral Suasion: It is a persuasion technique followed by Central Bank to pressurize the commercial banks to abide by the monetary policy, it involves meetings, seminars, speeches, etc.


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