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Monetary Policy Tools UPSC

Monetary policy, managed by the RBI in India, utilizes quantitative and qualitative tools to control money supply, interest rates, and credit availability for macroeconomic stability. Quantitative tools include the bank rate, repo rate, and cash reserve ratio, which broadly influence money supply, while qualitative tools like moral suasion and credit rationing direct credit allocation. An effective monetary policy combines both types of tools to achieve objectives such as price stability and economic growth.

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126 views3 pages

Monetary Policy Tools UPSC

Monetary policy, managed by the RBI in India, utilizes quantitative and qualitative tools to control money supply, interest rates, and credit availability for macroeconomic stability. Quantitative tools include the bank rate, repo rate, and cash reserve ratio, which broadly influence money supply, while qualitative tools like moral suasion and credit rationing direct credit allocation. An effective monetary policy combines both types of tools to achieve objectives such as price stability and economic growth.

Uploaded by

essshokha772
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Monetary Policy Tools: Quantitative & Qualitative (UPSC)

COMPREHENSIVE NOTES: QUALITATIVE & QUANTITATIVE TOOLS OF MONETARY POLICY

(UPSC)

INTRODUCTION:

Monetary policy refers to the process by which the central bank (RBI in India) controls the supply of

money, interest rates, and availability of credit in the economy to achieve macroeconomic objectives

like price stability, economic growth, and employment.

TOOLS OF MONETARY POLICY:

The tools of monetary policy are broadly classified into:

1. Quantitative Instruments (General Tools)

2. Qualitative Instruments (Selective Tools)

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1. QUANTITATIVE TOOLS (General Tools)

These tools affect the overall supply of money and credit in the economy. They are used for broad

monetary control.

1.1. Bank Rate:

- The rate at which RBI lends long-term loans to commercial banks.

- An increase in the bank rate makes borrowing from RBI more expensive, reducing money supply.

1.2. Repo Rate:

- The rate at which RBI lends short-term funds to banks against government securities.
- Reduction in repo rate encourages banks to borrow more, increasing liquidity.

1.3. Reverse Repo Rate:

- The rate at which RBI borrows money from commercial banks.

- Used to absorb liquidity from the banking system.

1.4. Cash Reserve Ratio (CRR):

- Percentage of a bank's total deposits that must be held in cash with the RBI.

- Higher CRR reduces lending capacity of banks.

1.5. Statutory Liquidity Ratio (SLR):

- Percentage of net demand and time liabilities that banks must maintain in the form of liquid assets

(gold, approved securities).

- Controls credit expansion and inflation.

1.6. Open Market Operations (OMO):

- Buying and selling of government securities by RBI in the open market.

- Buying securities injects liquidity; selling absorbs liquidity.

1.7. Liquidity Adjustment Facility (LAF):

- Includes Repo and Reverse Repo operations to manage day-to-day liquidity.

1.8. Marginal Standing Facility (MSF):

- Allows banks to borrow overnight funds from RBI in an emergency at a rate above repo.

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2. QUALITATIVE TOOLS (Selective Tools)


These tools aim at controlling the direction and purpose of credit, i.e., they influence credit

allocation.

2.1. Moral Suasion:

- RBI persuades banks to follow its directives through meetings, speeches, letters, etc.

2.2. Credit Rationing:

- RBI limits the maximum amount of credit in certain sectors to avoid excessive risk.

2.3. Margin Requirements:

- Margin is the difference between the value of a security and the loan granted.

- RBI changes margin requirements to regulate credit in speculative sectors.

2.4. Direct Action:

- RBI takes punitive action against banks that do not comply with its policies.

2.5. Regulation of Consumer Credit:

- RBI may regulate credit for consumption by setting conditions on installment purchases.

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CONCLUSION:

- Quantitative tools are effective for managing inflation and money supply.

- Qualitative tools are useful for directing credit into productive and priority sectors.

- An effective monetary policy uses both tools in tandem to stabilize the economy.

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