Explain different monetary policy instruments along with their effects on the Indian money market.

Published: May 27, 2019

The central bank uses several�instruments�of�monetary policy, referred to as�monetary�variables. They regulate the credit availability and liquidity in a manner that controls inflation and at the same time stimulate the growth of the economy. A number of monetary policy instruments are available in India which are as follows:
Open market operations

  • It is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks
  • The RBI sells government securities to control the flow of credit and buys government securities to increase credit flow
  • Open market operation makes bank rate policy effective and maintains stability in government securities market

Cash Reserve Ratio

  • Cash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances
  • The higher the CRR with the RBI, the lower will be the liquidity in the system and vice versa
  • It is currently 4 %

Statutory Liquidity Ratio

  • It is defined as the ratio of the liquid assets to time and demand liabilities
  • Every financial institution has to maintain a certain quantity of liquid assets with themselves at any point of time of their total time and demand liabilities
  • These assets have to be kept in non-cash form such as G-secs precious metals, approved securities like bonds etc
  • Current SLR is 19%

Repo Rate

  • Repo rate is the rate at which RBI lends to its clients generally against government securities
  • Reduction in repo rate helps the commercial banks to get money at a cheaper rate
  • Increase in repo rate discourages the commercial banks to get money
  • The Current Repo rate is 6%

Reverse Repo Rate

  • Reverse repo rate is the rate at which RBI borrows money from the commercial banks
  • This increase in repo rate and reverse repo rate is a symbol of tightening of the policy
  • The Current Reverse Repo rate is 5.75%

The goals of monetary policy are to promote maximum employment, stable prices and moderate long-term interest rates.

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