Monetary policy is the Macroeconomic Policy laid down by the central bank of the country. It refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption and growth.
In India, monetary policy of the Reserve Bank of India (RBI) is aimed at managing the quantity of money in order to meet the requirements of different sectors of the economy and to increase the pace of economic growth.
The goals of Monetary Policy:
The Reserve Bank’s Monetary Policy Department (MPD) assists the Governor in formulating the monetary policy.
Instruments of Monetary Policy
There are several direct and indirect instruments that are used in the implementation of monetary policy.
Reverse repo operation is when RBI borrows money from banks by lending securities. The interest rate paid by RBI is in this case is called the reverse repo rate. Reverse repo operation therefore absorbs the liquidity in the system.
It refers to the penal rate at which banks can borrow money from the central bank over and above what is available to them through the LAF window. MSF, being a penal rate, is always fixed above the repo rate. The scheme has been introduced by RBI with the main aim of reducing volatility in the overnight lending rates in the inter-bank market and to enable smooth monetary transmission in the financial system. MSF came into effect from 9th May 2011. MSF scheme is provided by RBI by which the banks can borrow overnight upto 1 per cent of their net demand and time liabilities (NDTL) i.e. 1 per cent of the aggregate deposits and other liabilities of the banks. However, with effect from 17th April 2012 RBI has raised the borrowing limit under the MSF from 1 per cent to 2 per cent of their NDTL outstanding at the end of the second preceding fortnight. The rate of interest for the amount accessed through this facility is fixed at 1 per cent above the repo rate for all scheduled commercial banks.
Starting with the first bi-monthly statement of monetary policy in April 2014, the Reserve Bank has changed the normal frequency of monetary policy announcements from eight times in a year (i.e., four quarterly and four mid- quarter) to six times in a year (i.e., bi-monthly).
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