Explain Various Quantitative Instruments of Monetary Policy Which Are Undertaken To Control Inflation

Explain various quantitative instruments of monetary policy which are undertaken to control inflation.
Monetary policy is a central bank's actions and communications that manage the money supply. The
money supply includes forms of credit, cash, checks, and money market mutual funds. Monetary policy
increases liquidity to create economic growth. It reduces liquidity to prevent inflation. Central banks use
interest rates, bank reserve requirements, and the number of government bonds that banks must hold.
All these tools affect how much banks can lend. The volume of loans affects the money supply.
THE QUANTITATIVE INSTRUMENTS USED ARE:
Bank Rate
 The rate of interest at which the central bank lends money to commercial banks is called bank
rate or discount rate. A change in bank rate affects money and credit supply. If the bank rate is
increased, borrowings by commercial becomes expensive, which in turn increases the lending
rate. It is called hardening of interest rates and discourages retail borrowings.
 It is the rate at which the Central Bank (CB) discounts the securities of commercial banks. Bank
rate influences the cost of credit. Changes in discount rate and bring changes in short term and
long term interest rates and thereby the level of economic activity. Thus it influences both
availability and cost of credit.
 During inflation Central Bank increases the bank rate, due to which credit from Central Bank
becomes costlier.
 As a result commercial banks are discouraged to borrow from Central Bank. When bank rate is
increased, other lending rates will also rise making credit costlier. Hence investments will
decline leading to a fall in employment, income and demand for goods and services. This in turn
will reduce the price level.
 Same way, during depression bank rate is reduced to push demand upwards. For the bank rate
to succeed, commercial banks should not have excess reserves with them and they should have
adequate securities to be discounted with the CB. Presently the bank rate is 5.65%
Open Market Operations
 Open market operations refers to buying and selling of government securities by RBI. The
Central Bank sells securities to commercial banks and public. This increases money supply with
RBI and at the Same time reduces deposits with commercial bank. This also reduces credit
Creation capacity of commercial banks.
 It refers to buying and selling of govt. securities by the CB.
 During inflation, there is too much money supply in the economy. At this point of time, CB sells
securities which is purchased by commercial banks. This reduces the cash reserves of
commercial banks thereby leading a reduction in credit creation, leading to reduction in money
supply.
 As a result demand is reduced and there is price reduction. Same way, during depression CB
buys govt. securities from commercial banks, leading to increase in money supply to commercial
banks and accordingly further.
Cash Reserve Ratio (CRR)

 Cash Reserve Ratio (CRR) is a specified minimum fraction of the total deposits of customers,
which commercial banks have to hold as reserves either in cash or as deposits with the central
bank. CRR is set according to the guidelines of the central bank of a country
 It is a powerful instrument in the hands of CB to control credit. Commercial banks have to keep
a certain percentage of their deposits with theCB. It is a statutory requirement to ensure
liquidity and solvency of the banks.
 By adjusting CRR, credit creation can be controlled. During inflation the CB increases the CRR, as
a result funds available with commercial banks for credit creation will decrease. During
depression, CRR is reduced to increase liquidity in the economy. In 1991 CRR was 15% and in
2020 it is 4%.
Statutory Liquidity Ratio (SLR)
 Statutory Liquidity Ratio or SLR is the minimum percentage of deposits that a commercial bank
has to maintain in the form of liquid cash, gold or other securities. It is basically the reserve
requirement that banks are expected to keep before offering credit to customers.
 Through SLR, the CB can control the credit created by commercial banks. During inflation, SLR is
increased to contract credit created by commercial banks.
 In 1991 SLR was 38.5% and in 2020 it is 18.25%.
Repo Rate
 Repo Rate, or repurchase rate, is the key monetary policy rate of interest at which the central
bank or the Reserve Bank of India (RBI) lends short term money to banks, essentially to control
credit availability, inflation, and the economic growth.
 It is the rate at which the CB gives loans and advances to commercial banks against their
securities.
 During inflation it is increased resulting in increased cost of loans to commercial banks, which in
turn will pass on the same to the borrowers, thereby increasing the cost of credit. Presently it is
5.40%.
Reverse Repo Rate
 Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in
case of India) borrows money from commercial banks within the country. It is a monetary policy
instrument which can be used to control the money supply in the country
 It is the rate at which commercial bank park their funds with the CB. In other words, it is the rate
at which the CB borrows from commercial banks.
 During inflation, it is increased, thereby banks will be induced to park their funds with CB rather
than to lenders, and therefore credit availability is reduced.
 When repo rate is revised, Reverse repo rate is automatically revised. Presently it is 5.15%.
List out the qualitative instruments which the central bank adopts to fight recession.
When the economy is faced with recession or involuntary cyclical unemployment, which comes
about due to fall in aggregate demand, the central bank intervenes to cure such a situation.
Central Bank takes certain measures to expand the money supply in the economy and/or lower
the rate of interest with a view to increase the aggregate demand which will help in stimulating
the economy.
QUALITATIVE MEASURES:
Minimum Margin Requirements
 Margin requirement refers to the difference between the current value of the security offered
for loan (called collateral) and the value of loan granted. It is a qualitative method of credit
control adopted by the central bank in order to stabilize the economy from inflation or
deflation.
 When lending commercial banks accept securities, they deduct a certain margin from the
market value of security. This margin is fixed by CB and adjusted according to the requirements.
Margin requirements range between 20% to 75%. When credit has to be expanded, margins are
lowered and the same is increased when credit needs to be contracted.
Ceiling on credit
 Ceiling on credit refers to fixation of credit quotas for different business activities which is
introduced when the flow of credit is to be checked particularly for speculative activities in the
economy.
 It implies fixing a limit for different types of loans sanctioned by banks. Through this, lending
capacity of banks is influenced by RBI.
Moral Suasion
 The central bank makes the member bank agree through persuasion or pressure to follow its
directives which is generally not ignored by the member banks. The banks are advised to restrict
the flow of credit during inflation and be liberal in lending during deflation.
 RBI uses persuasion to influence lending activities of banks.
 Discussions on a periodical basis are held by RBI with banks to control the flow of credit to the
desired sectors.
Direct Action
 It is an extreme step taken by RBI. It involves refusal by RBI to extend credit facilities, denial of
permission to open new branches etc.
 Central bank uses a combination of Quantitative and Qualitative instruments credit control
methods to bring about economic stability. They are adjusted according to the requirements of
the economy.

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Explain Various Quantitative Instruments of Monetary Policy Which Are Undertaken To Control Inflation

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Explain various quantitative instruments of monetary policy which are undertaken to control inflation.

THE QUANTITATIVE INSTRUMENTS USED ARE:

Open Market Operations

Cash Reserve Ratio (CRR)

Statutory Liquidity Ratio (SLR)

Reverse Repo Rate

Minimum Margin Requirements

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