Monetary Policy: Objectives and Instruments

Monetary policy is the policy of the central bank to regulate the supply and cost of money and credit in the economy in order to achieve broad objectives — price stability, economic growth, full employment, and exchange-rate stability. The RBI carries it out through two sets of instruments.

(A) Quantitative (general) instruments — these affect the overall volume of credit:

• Bank Rate — the rate at which the RBI lends long-term funds to commercial banks; raising it makes borrowing costlier and contracts credit.
• Repo Rate — the rate at which the RBI lends short-term funds to banks against securities (repurchase agreements); a higher repo rate raises banks' borrowing cost and reduces credit. The Reverse Repo Rate is the rate at which the RBI borrows from banks, absorbing liquidity.
• Cash Reserve Ratio (CRR) — the fraction of deposits banks must keep with the RBI; raising it reduces the funds available for lending and contracts credit (via the smaller multiplier of Section 3).
• Statutory Liquidity Ratio (SLR) — the fraction of deposits banks must hold in liquid assets (cash, gold, approved securities); raising it also reduces lending capacity.
• Open Market Operations (OMO) — the RBI's buying and selling of government securities in the market; selling securities withdraws cash from banks (contracts credit), buying them injects cash (expands credit).

(B) Qualitative (selective) instruments — these affect the direction and use of credit rather than its total volume:

• Margin requirements on loans against specified securities.
• Regulation of consumer credit (down-payment and instalment terms).
• Moral suasion — persuasion and advice by the RBI to banks. …