August 30, 2018

What are Monetary Policies & how does one judge them ? how do they impact Economy?

What are Monetary Policies & how do one judge them ? how do they impact Economy?

I am sure most of you may be having this question – with the raising & lowering of interest rates of your loans & having an effect on your EMI’s. Well, monetary policies are administered by Central bank in an economy to deal with – supply of money, inflation, interest rates for the purpose of promoting economic growth & also to manage price stability in the market. 

Monetary policies can either expand or contract depending on the policy stance. We call the policy as ‘Expansionary Monetary Policy’ – as it pushes the economy up by increasing the supply of money supply steeply with reduction in interest rates. Naturally – when lesser interest rates – people start borrowing more & when everybody has more money – people will be ready to pay higher for products that they want to to buy. On the other hand ‘Contraction Policy’ is intended to cool down the heated up economy through reduction in the money supply by increasing the interest rates.

Central Bank or RBI in India, controls the money supply & interest rates with tools such as

  • ‘Repo Rate’ – Rate at which central bank lends money to commercial banks
  • ‘Reverse Repo Rate’ – Rate at which central bank borrows money from commercial banks
  • ‘Cash Reserve Ratio’ – Minimum percentage of deposits, which commercial banks have to hold as Cash reserves with the central bank
  • ‘Statutory Liquid Ratio’ (SLR) – Minimum percentage of the total deposits, which commercial banks have to hold in cash equivalents such as gold & government of India Securities.

So these are the tools which Central banks of any country would use to have its impact on the economy & to put the country on to a progressive forward footing. Having said this, there are no sure short formula to handle economic issues such as Slowing down in growth, Inflation, exchange rates management & others. Every country has different factors that determines its GDP. So given the variation in the composition of the GDP, growth rate, demographic features of different economies – the same policy action may have different outcomes in different economies/countries.

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