Monetary Policy

What Is Monetary Policy? managing financial stability risks. The assessments often are
Monetary policy is a set of tools used by a nation's central bank contained in technical notes, such as these for Finland,
to control the overall money supply and promote economic Netherlands, and Romania.
growth and employ strategies such as revising interest rates
and changing bank reserve requirements. Technical assistance helps countries develop more effective
institutions, legal frameworks, and capacity. It may entail
Central banks use monetary policy to manage economic monetary policy, exchange rate regimes, or macroprudential
fluctuations and achieve price stability, which means that policies. It can also help countries move toward inflation
inflation is low and stable. Central banks in many advanced targeting or improve central bank operations, such as open
economies set explicit inflation targets. Many developing market operations and foreign exchange management.
countries also are moving to inflation targeting.
The IMF’s Central Bank Transparency Code (CBT) helps central
Central banks conduct monetary policy by adjusting the supply banks to guide their transparency practices, as a prerequisite
of money, usually through buying or selling securities in the for central bank independence. The CBT reviews, conducted by
open market. Open market operations affect short-term IMF staff, provide a view on central bank transparency and
interest rates, which in turn influence longer-term rates and facilitate more effective dialogue between the central bank and
economic activity. When central banks lower interest rates, its various stakeholders.
monetary policy is easing. When they raise interest rates,
monetary policy is tightening. To inform policy development and research, the IMF works
with its members to create and maintain databases. For
How has monetary policy been used recently? example:
After the global financial crisis that started in 2007, central
banks in advanced economies eased monetary policy by The IMF tracks countries’ monetary policy arrangements
reducing interest rates until short-term rates came close to (AREAER), central banks’ legal frameworks (CBLD), and
zero, limiting options for additional cuts. Some central banks monetary operations and instruments (MOID).
used unconventional monetary policies, buying long-term
bonds to further lower long-term rates. Some even took short- The IMF has an annual survey with details on macroprudential
term rates below zero. In response to the COVID-19 pandemic, measures and institutions, enabling comparisons across
central banks took actions to ease monetary policy, provide countries and over time.
liquidity to markets, and maintain the flow of credit. To
mitigate stress in currency and bond markets, many emerging The IMF’s comprehensive historical database of
market central banks used foreign exchange interventions, and macroprudential measures (iMaPP) integrates the latest
for the first time, asset purchase programs. More recently, in survey information. IMF economists use the database to
response to rapidly growing inflation, central banks around the measure policy effects. It is also freely available to researchers.
world have tightened monetary policy by increasing interest
rates. The IMF has comprehensive, structured data on central banks’
direct market interventions. For example, IMF economists used
Monetary policy and exchange rates the Central Bank Interventions Database (CBID) to track efforts
to support financial markets during the COVID-19 pandemic.
A country’s monetary policy is closely linked to its exchange
rate regime. A country’s interest rates affect the value of its Tools of Monetary Policy
currency, so those with a fixed exchange rate will have less
scope for an independent monetary policy than ones with a Central banks use various tools to implement monetary
flexible exchange rate. A fully flexible exchange rate regime policies. The widely utilized policy tools include:
supports an effective inflation-targeting framework.
1. Interest rate adjustment
What role does the IMF play in monetary policy and central A central bank can influence interest rates by changing the
banking? discount rate. The discount rate (base rate) is an interest rate
charged by a central bank to banks for short-term loans. For
The IMF promotes the effectiveness of central banks through example, if a central bank increases the discount rate, the cost
its policy advice, technical assistance, and data collection. of borrowing for the banks increases. Subsequently, the banks
will increase the interest rate they charge their customers.
In bilateral policy advice, known as Article IV consultation, the Thus, the cost of borrowing in the economy will increase, and
IMF is in regular dialogue with country central banks. It may the money supply will decrease.
provide advice on establishing effective frameworks for
monetary policy and macroprudential policy, as well as 2. Change reserve requirements
monetary policy actions. Central banks usually set up the minimum amount of reserves
that must be held by a commercial bank. By changing the
As part of its financial surveillance, the IMF’s Financial Sector required amount, the central bank can influence the money
Assessment Program (FSAP) provides member countries with supply in the economy. If monetary authorities increase the
an evaluation of their financial systems and advice on required reserve amount, commercial banks find less money

Courses Offered: CAT | GMAT | CET | NMAT | IBPS | SBI | RBI | SSC
Head Office: Planet E, 104, Civic Center, MMGS Marg, Near Railway Station, Dadar (East), Mumbai
Contact: 9920974347/9324023344 | www.planete.in |www.youtube.com/c/planetetestprep |Instagram: planete.mumbai
 Monetary Policy
available to lend to their clients, and thus, money supply Bank Rate: Bank Rate is the rate at which commercial banks
decreases. can borrow money from RBI. The Bank Rate movement
indicates the long term health of the economy. Upward revision
Commercial banks can’t use the reserves to make loans or fund of Bank Rate will make funds costlier for banks which may
investments into new businesses. Since it constitutes a lost result in banks raising their lending rates.
opportunity for the commercial banks, central banks pay them
interest on the reserves. The interest is known as IOR or IORR
(interest on reserves or interest on required reserves).

3. Open market operations

The central bank can either purchase or sell securities issued
by the government to affect the money supply. For example,
central banks can purchase government bonds. As a result,
banks will obtain more money to increase the lending and
money supply in the economy.

RBI and Its Functions

Accepting Deposits and lending the same are the main

activities of banks. Bank credit plays an important role in the
growth of the economy. Apart from economic growth, Reserve
Bank of India (RBI) closely monitors the level of inflation
prevailing in the country. Maintaining monetary stability is an
important responsibility of RBI.
One of the definitions of inflation is too much money chasing
too few goods. RBI has to balance between the growth of
economy and level of inflation. The central bank of the country
watches carefully their movement and intervenes to take
corrective steps whenever necessary. To achieve its objective it
requires some tools through which it can influence their
movement.

Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR),

Repo Rate , Reverse Repo Rate and Bank Rate are some of the
tools available with Reserve Bank of India to achieve these
objectives,

Cash Reserve Ratio (CRR): CRR is the portion of the deposits

(total demand and time liabilities) of a bank to be kept as cash
reserve. The banks can maintain the cash reserve in the form of
cash with the bank itself or credit balance in its account
maintained with RBI. It is a statutory requirement.

Statutory Liquidity Ratio (SLR): SLR is the portion of deposits

(net demand and time liabilities) of a bank to be maintained as
cash, gold or approved securities. To certain extent this ensures
the liquidity and safety of deposits of the bank apart from
acting as a tool for RBI to maintain monetary stability.

Repo Rate: Repo Rate is the rate at which banks can borrow
money from RBI against listed securities with agreement to
repurchase the securities at a specified future date from RBI.
Mostly banks use Repo mechanism to meet their short term
requirement for funds.

Reverse Repo Rate: Reverse Repo Rate is exactly the opposite

of the Repo Rate. Banks can park their funds with RBI to take
advantage of the higher Reverse Repo Rate.

Courses Offered: CAT | GMAT | CET | NMAT | IBPS | SBI | RBI | SSC
Head Office: Planet E, 104, Civic Center, MMGS Marg, Near Railway Station, Dadar (East), Mumbai
Contact: 9920974347/9324023344 | www.planete.in |www.youtube.com/c/planetetestprep |Instagram: planete.mumbai