Monetary Policy CRR, SLR, BANK RATE, RR and RRR and OMO - ECONOMICS QUIZ.....important for all competitive exams

WHAT IS MONETARY POLICY?

In an easy way, we can define monetary policy as the set of rules made by the central bank of any country ( RBI in India ) to control the flow of credit or money in the market of that country.

This policy is made by Central Bank of a country to ensure growth of economy and mainly to control inflation or deflation.

In India, monetary policy is made by Reserve Bank of India.

RBI uses this policy to relax of contract flow of money in the market for maintaining growth of country and the inflation rates.

So in an easy term we can say it is the way to control inflation or deflation rates by the RBI.

RBI uses two methods to give effects to its monetary policy.They are:

1) Qualitative method.

2) Quantitative method.

For competition exams quantitative method is more important than qualitative, so here we will know discuss about quantitative only.

Quantitative method:

In this method there are six instruments( ways to control inflation rates ).They are:

1- Cash reserve ratio (CRR): 

This ratio determines the minimum amount of reserve(money) that any bank in India have to deposit in RBI.

If CRR rate is increased by RBI, banks have to deposits in RBI more of their money then before, its consequence will be, the amount of money now that bank can lend to their customers will be less than before and due to this loan rates will become high because of more demand of loans.Consequently, the amount of money in market will decrease which will lead to decrease in price of things and articles.This will lead to decrease in inflation rates.

So..if CRR increases, inflation decreases and if CRR decreases inflation increases.

2- Statutory Liquidity Ratio:

It is the percentage of total credit of bank that it should have in liquid form, that is, in currency or gold form.

When RBI increases SLR then the liquidity that is, amount of money with bank in currency form or gold form increases, this ensures that now bank could lend more customers. Consequently, the loan rates become lower, because of that more and more customers take loans and due to this money in market increases.

This lead to increase in price of things and articles.Eventually, Inflation increases.

So, if SLR increases, inflation increases and if SLR decreases then inflation decreases.

3- Bank Rate:

It is the rate at which loan is given by RBI to other banks for long term.

If bank rate decreases, then banks will take more and more loan from RBI because of lower rates. Consequently, other banks will also reduce their loan rates in turn for people. Because of that more and more people will take loan, which will increase supply of money in market. This will increase price of things and articles.Consequently, the inflation rises.

So, if Bank Rate decrease, inflation increases. And if Bank Rate decreases, Inflation decreases.

4- Repo Rate:(RR)

It is the rate at which banks lend from RBI for a very short term. For eg. 24 hours or two days etc.

If Repo rate increases then banks will reduce their lending for short term from RBI, this will lead to less amount of money with banks. Because of that loan rates will increase and less people will get loan from commercial banks then before. Consequently, money supply in market will decrease and the price of commodities will go down. Because of this inflation decreases.

SO, if Repo rate increases, Inflation decreases and if Repo rate decreases then inflation increases.

5- Reverse Repo Rate: (RRR)

As it name has reverse, it is opposite of repo rate. It is the rate at which RBI borrow money from commercial banks to control inflation.

If RRR will be high, more and more commercial banks will deposit their money to RBI so they can get more interest than from market. Because of that loan rates for market increases in turn of that money supply in market also decreases which leads to decrease in inflation.

So, if RRR increases, inflation decreases and if RRR decreases inflation increases.

6- Open Market Operations:(OMO) 

It refers to the selling and buy of Government securities by RBI to expand of contract the amount of money in Indian banking system.

If more and more securities will be sold by RBI then amount of money in banking system and market will decrease because of this inflation decreases.

So, if OMO increases, inflation decreases and if OMO decreases then inflation increases.