Monetary policy

Description on Monetary policy

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Monetary policy by Mind Map: Monetary policy

1. What is it?

1.1. Policy adopted by central bank to check Interest rates, Money supply and Availability of credits.

1.1.1. Why?

1.1.1.1. To control inflation in the country

2. Expansionary monetary policy

2.1. focused on expanding money supply in market

2.1.1. how?

2.1.1.1. by lowering key interest rates thus increasing market liquidity

3. Contractionary monetary policy

3.1. focused on contrcating money supply

3.1.1. by increasing key interest rates thus reducing market liquidity

4. RBI mandated through RBI act 1934

4.1. Recently formed Monetary Policy Framework (MPF), Monetary Policy Committee (MPC), and Monetary Policy Process (MPP)

4.1.1. Monetary policy framework

4.1.1.1. aims at setting the policy (repo) rate

4.1.1.2. Repo rate changes transmit through the money market to the entire financial system

4.1.1.3. Reserve Bank envisages liquidity management on a day-to-day basis

4.1.2. Monetary Policy Committee (MPC)

4.1.2.1. policy interest rate required to achieve the inflation target is decided by the Monetary Policy Committee

4.1.2.2. MPC is a six-member committee constituted by the Central Government

4.1.2.3. MPC is required to meet at least four times a year

4.1.2.4. Once in every six months, the Reserve Bank is required to publish a document called the Monetary Policy Report to explain: (1) the sources of inflation and(2) the forecast of inflation for 6-18 months ahead.

4.1.3. Monetary policy Process

4.1.3.1. The Reserve Bank’s Monetary Policy Department (MPD) assists the MPC in formulating the monetary policy.

4.1.3.2. The Financial Markets Operations Department (FMOD) operationalises the monetary policy

4.1.3.3. The Financial Market Committee (FMC) meets daily to review the liquidity conditions.

5. Main goal of Monetary Policy

5.1. Maintain price stability

6. Flexible Inflation Targeting Framework

6.1. what is it?

6.1.1. Publicly announced inflation target by the government in consultation with RBI for five years.

6.1.2. Current Inflation target is around 4%

6.1.2.1. tolerance of up to 6% at the highest and 2% at the lowest

6.1.2.2. Failures if: for three consecutive quarters there is a upper tolerance level of Inflation target.

6.1.2.3. Failure if: Average inflation is less than lower tolerance level for three consecutive quarters.

7. Monetary Policy instruments

7.1. Repo Rate: Reserve Bank provides overnight liquidity to banks against the collateral of government.

7.2. Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs liquidity from commercial banks.

7.3. Liquidity Adjustment Facility (LAF): The LAF consists of overnight as well as term repo auctions.

7.4. Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can borrow an additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR)

7.5. Bank Rate: It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers.

7.6. Cash Reserve Ratio (CRR): The average daily balance that a bank is required to maintain with the Reserve Bank

7.7. Statutory Liquidity Ratio (SLR): The share of NDTL that a bank is required to maintain in safe and liquid assets, such as unencumbered government securities, cash and gold.

7.8. Open Market Operations (OMOs): These include both, outright purchase and sale of government securities, for injection and absorption of durable liquidity, respectively.

7.9. Market Stabilisation Scheme (MSS): Surplus liquidity of a more enduring nature arising from large capital inflows is absorbed through the sale of short-dated government securities and treasury bills.