Blog - February 18, 2022

Monetary Policy and Stagflation : Keynes Meets Classics Economic and Political Weekly

This could eventually result in a run on the domestic currency, perpetuating a currency crisis. By utilising subsidies, transfer payments , and tax cuts on wages, expansionary fiscal policy brings more money into the hands of consumers to give them more purchasing power. The reverse repo rate under the Liquidity Adjustment Facility is 6%. The Marginal Standing Facility rate and Bank rate is 6.50% as well.

Banks are allowed to earn interest on these securities, however it is very low. Cash Reserve Ratio – Banks are required to set aside this portion in cash with the RBI. The bank can neither lend it to anyone nor can it earn any interest rate or profit on CRR. When banks are sufficiently capitalised, it means that they have enough assets that can be converted to cash to meet short-term and long-term obligations. Monetary policy should usually work with the Fiscal policy by the national government. Government lenders are re-elected for increasing spending or reducing taxes.

When the RBI sells government securities, the liquidity is sucked from the market, and the exact opposite happens when RBI buys securities. The objective of OMOs are to keep a check on temporary liquidity mismatches in the market, owing to foreign capital flow. Quantitative easing is constructed as forward guidance regarding interest rate level. In a QE, the Central bank purchases large amounts of risky as well as risk free securities.

example of monetary policy

The RBI implements the monetary policy through open market operations, bank rate policy, reserve system, credit control policy, moral persuasion and through many other instruments. Using any of these instruments will lead to changes in the interest rate, or the money supply in the economy. Monetary policy can be expansionary and contractionary in nature. Increasing money supply and reducing interest rates indicate an expansionary policy. Open market operations – The process of buying and selling of securities by the central bank is referred to as open market operations. Buying of securities by the central banks makes more funds available for lending.

Rapid selloffs by US-based funds would put downward pressure on the rupee, as foreign investors would convert their equity investments in the rupee to the US dollar. The rupee depreciation would also result in imported inflation as India relies heavily on oil imports to meet domestic demand. With no signs of inflation abating soon, the Fed may hike rates four times in 2022, beginning in March, and another four times in 2023.

Mutual fund Investments

The influence of monetarism has been seminal for every decade facing a recession. Bigger economies have long been in a “liquidity trap” situation, in which real interest rates are sluggish and close to zero, often negative. The consequences of the risks involved with increasing the money supply in the economy have thus been disproved. Economists have long been scrambling for an explanation for this and new schools of thought have arisen to explain the rationale behind policies such as “helicopter money” and “quantitative easing”. This is not to say that govt and corporate do not want low inflation, they do but their primary focus lie elsewhere.

This is the first time the repo rate was increased after the current government took charge. RBI governor, Urjit Patel held a meet for 3 days with a 6-member Monetary Policy Committee before the rate hike was announced. The repo rate remained unchanged at 4% and the reverse repo rate at 3.35%, the RBI Governor Shaktikanta Das said. By buying riskier securities from banks as well as other financial institutions and pushing down the yield on long term Government bonds, QE makes it profitable for banks to deploy money via loans to businesses and individuals. Now that we understand what a repo rate is, let’s check out how the repo rate is manipulated to change the money supply in the economy. The Financial Market Committee meets daily to review the liquidity conditions so as to ensure that the operating target of monetary policy is kept close to the policy repo rate.

example of monetary policy

Since March 2020, this reserve requirement has been reduced to 0 by the Fed. The central bank can sell or purchase securities issued by the government will affect the money supply. But we see in India, even when RBI decreases rates banks don’t pass on the benefits to consumers and when banks raise interest rates when RBI raises rates, inflation does not come down.


It is very easy to understand the need and importance of a central bank. Ever tried to imagine what would happen if the referee is not present? In wrestling, a wrestler can easily cheat and use wrong moves to defeat his opponent. Similarly, in a football match, a goal might be claimed, even if scored after offside. Central bank is the big boss and can be considered as referee of the banking system. The Central bank drafts rules that all participants of the system need to adhere to and ensures implementation of these rules.

Composition of such a committee- for autonomy it is important to have either RBI members majority or equal numbers from both sides with governor exercising a casting example of monetary policy vote . Margin Requirements- RBI can prescribe margin against collateral. For instance, lend only 70 rs for 100 rs value gold, margin requirement being 30%.

  • Alternatively, there is also a need to figure out how to increase farmers’ participation in the commodity futures market.
  • The tapering of the Fed’s asset-purchase program is the first significant step toward normalising its ultra-loose monetary policy.
  • Of the two types of instruments, the first category includes bank rate variations, open market operations and changing reserve requirements .
  • It deals with monetary i.e money matters i.e. affects money supply in the economy.
  • There are three basic tools used by all central banks for monetary policy.
  • Quantitative tools or general tools-they affect money supply in entire economy- housing, automobile, manufacturing, agriculture- everything.

To put this in context, India’s total external debt maturing until September 2022 accounts for 40% of the country’s forex reserves. As the COVID-19 pandemic enters its third year, emerging market economies will continue to struggle to improve their financial resilience in the face of numerous domestic and global headwinds. Emerging market economies and low-income countries should initiate swift domestic policy responses to minimise the effects of tightening US monetary policy. The two significant examples include increased government spending as well as tax cuts. These policies seek to raise aggregate demand while leading to deficits or drawing the decline of budget surpluses. They are employed during recessions or in the midst of one’s worries to spur a recovery or head off a recession.

Our Goods & Services Tax course includes tutorial videos, guides and expert assistance to help you in mastering Goods and Services Tax. ClearTax can also help you in getting your business registered for Goods & Services Tax Law. But what happens if the cause of inflation is supply-side factors and/or speculation? Supply of output can get affected because of drought (especially when around 55% of our agricultural produce depends on rainfall), capacity constraint and because of speculation. Targeted relief packages are the only way one can hope to contain some of the dire costs of the engine of the economy grinding to a halt, but, more importantly, in lives being saved.

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According to theInstitute of International Finance’s Capital Flows Tracker, foreign investment in emerging market stocks and bonds has declined since December 2020, owing to concerns about fragile economic recovery. To contain the economic fallout of the COVID-19 pandemic, the Federal Reserve took a broad array of actions, including expansionary policy and ‘quantitative easing’ (large-scale buying of bonds and securities). The Fed has been purchasing $120 billion ($80 billion of treasury securities and $40 billion of mortgage-backed securities) every month since March 18, 2020, to support the US economy.

Was used in the monetary policy statement which was a clear signal to the markets of a dovish outlook on interest rates. We also find that this expansionary shock is captured in our measure. Primarily due to the Fed’s selective approach, bilateral currency swap arrangements between EMEs have proliferated in recent years.

The Monetary Policy Framework

Bank earns no interest rate or profit on this.Bank cannot lend it to anyone.

The US Fed’s Aggressive Monetary Policy Tightening and New Headwinds for Emerging Markets

The supply-side economics theory suggests reducing corporate taxes rather than payroll taxes and supports lower capital gains taxes to boost spending by companies. Government intends to bring down the interest rates on small saving accounts. If the small saving rates are linked to the bank rate, this could serve as a permanent solution. Both the government and RBI has taken and plans to take some steps in order to accelerate the transmission of monetary policy.

For example, to slow growth and reduce inflation, the contractionary policy is used as it raises interest rates and limits the outstanding money supply. The prices of goods and services rise, reducing the purchasing power of money. The commercial banks, in reaction, raise their lending rates to the business community and borrowers who further borrow less from the commercial banks. There is a contraction of credit and prices are checked from rising further. On the contrary, when prices are depressed, the central bank lowers the bank rate.

The Chakravarty committee has emphasized that price stability, growth, equity, social justice, promoting and nurturing the new monetary and financial institutions have been important objectives of the monetary policy in India. The decrease in long-term interest rates also causes the currency to depreciate in the foreign exchange market. The buying of securities by the central bank increases the cash reserves. The challenge lies in designing an appropriate policy mix depending on the potential macroeconomic and financial risks.

ClearTax serves 1.5+ Million happy customers, 20000+ CAs & tax experts & 10000+ businesses across India. The funds is expected to be above Rs.3,000 crore which was previously approved in a meeting held by the board of Bank of Baroda in 27 May 2017. While carrying out the Annual Financial Inspections of the banks, RBI found divergence between the NPAs and provisions declared by the banks and the ones assessed during the inspection. As on 31 March 2017, the ICRA estimated that the gross NPA stood at Rs.54,100 crore for banks for which RBS audit was done. RBI has issued a revised framework which requires banks to employ a resolution plan for special mention accounts. As there is an expectation of 6-7% annualised slippage during the 4th quarter of FY18, the gross NPA can increase to Rs.9.3 lakh crore by 31 March 2018 as per the ICRA estimates.

Monetary policies are traditionally viewed as having no direct effect on aggregate supply. For example, If a bank doesn’t maintain CRR, SLR as per the prescribed limit, penalty is prescribed as per bank rate. Now again as per Government rule, bank will have to retain 10% of the deposit and can lend rest of the amount. This time bank will retain INR 90 (10% of INR 900) and will lend out only INR 810.

When the central bank finds that inflation has been increasing continuously, it raises the bank rate so borrowing from the central bank becomes costly and commercial banks borrow less money from it . There is a systematic relationship of government bond yields and stock prices with surprise news about the policy rate. Contractionary monetary shocks raise government bond yields and lower stock prices but do not impact the exchange rate. Ten-year government bond yields respond substantially more to information revealed in RBI statements about the future path of monetary policy, rather than to surprise changes in the short-term policy rates.

Additionally, major elections will be held in 2022 in several emerging market countries amid a polarised political environment, lingering popular discontent and widening economic inequalities. All of these developments could have a significant adverse effect on the outlook of EMEs. Just upload your form 16, claim your deductions and get your acknowledgment number online.