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In an economy, the Government and the RBI work together to establish stability and growth. The Government uses fiscal policy while the RBI is empowered with monetary policy.
Monetary policy deals with regulation of money supply and interest rates with intention to address issues like inflation, currency appreciation and depreciation and general economic activity. For this purpose, Monetary policy Committee was established which conducts meeting at least four times a year.
Inflation refers to general increase in price of goods and services leading to erosion of purchasing power of money. This could happen due to two factors, namely demand being in excess of supply or, an increase in cost of inputs used for manufacture that causes the final products to become costly.
To tackle inflation, the RBI tries to reduce the demand or increase the supply or both.
Interest and inflation are closely related as in an economy. To understand how this works, remember that an economy is a function of demand and supply. An increase in demand reflects that people are consuming more goods and services and saving less. This also means that the economic activity or production is increasing. An increased production invites more people to start businesses as economy booms. This leads to businesses buying more machinery and factories by taking loans at cheaper interest rates. This causes prices to rise.
RBI uses measures like repo rate, reverse repo rate to adjust the economic activity. When prices rise, the RBI increases interest rates. This makes setting up businesses, taking personal loans or spending costlier. It promotes saving. As more and more people save (and spend less on new car or home), consumption goes down. With reduced consumption, the prices which were high begins to come down as demand decreases.
This establishes balance in economy and curbs inflation.
The Reserve Bank of India (RBI) uses monetary policy tools to contain inflation by adjusting interest rates, regulating money supply, and managing liquidity in the economy.
*Key Monetary Policy Tools:*
-*Interest Rates*: RBI increases interest rates to reduce borrowing, consumption, and investment, thus reducing demand and subsequently inflation .
*Money Supply*: RBI regulates money supply by buying or selling government securities, which affects the amount of money available for lending and spending.
*Liquidity Management*: RBI manages liquidity through instruments like Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR), influencing banks’ lending capacity.
*Recent Actions:*
RBI has taken steps to control inflation, including a cumulative 250 basis points increase in policy rates and withdrawal of accommodation, guiding inflation down to an average of 5.4% in 2023-24 .
*Inflation Targets:*
RBI aims to keep inflation within the tolerance band of 2-6% .
*Challenges:*
RBI faces challenges in balancing inflation control with economic growth. Uncertainty shocks, like those experienced during the pandemic, can lead to slower growth and higher inflation .
The Reserve Bank of India (RBI) uses monetary policy to contain inflation through various tools. One key tool is adjusting the repo rate, which is the rate at which banks borrow money from the RBI. By keeping the repo rate unchanged at 6.5% for the tenth consecutive meeting, as decided in October 2024, the RBI aims to balance economic growth and inflation control ¹.
*Monetary Policy Tools:*
– *Repo Rate*: Influences borrowing costs for banks and subsequently affects the overall economy.
– *Standing Deposit Facility (SDF) Rate*: Determines the interest rate paid on deposits.
– *Marginal Standing Facility (MSF) Rate*: Sets the borrowing rate for banks.
– *Bank Rate*: Regulates the interest rate for loans.
The RBI also considers other factors, such as food inflation, global economic trends, and geopolitical risks, when making monetary policy decisions ². By analyzing these factors, the RBI can adjust its stance to “neutral,” allowing for flexibility in interest rate adjustments according to inflation trends .
*Inflation Projections:*
The RBI has projected CPI inflation for 2024-25 at 4.5%, with balanced risks . Food inflation remains a significant source of uncertainty, and the RBI monitors it closely to prevent spillover effects .
Overall, the RBI’s monetary policy plays a crucial role in containing inflation while promoting economic growth. By carefully balancing various tools and factors, the RBI aims to maintain price stability and ensure a healthy economy.
The Reserve Bank of India (RBI) is the central bank regulating India’s monetary policy, banking system and foreign exchange management.The Reserve Bank of India (RBI) uses monetary policy tools to contain inflation by managing the money supply, interest rates and credit availability.
By using these monetary policy tools, RBI aims to contain inflation by reducing demand for goods and services, managing money supply and influencing credit availability.