Monetary Policy Tools: A Ready Reckoner Table Flashcards
What are the two primary types of reserve requirements central banks might impose?
CRR (Cash Reserve Ratio): The percentage of a bank’s deposits that must be held as reserves with the central bank.
SLR (Statutory Liquidity Ratio): The percentage of a bank’s deposits that must be held in approved liquid assets (like government securities).
Describe how decreasing key interest rates, such as the Repo Rate, impacts the economy.
Effect on Credit: Lower interest rates make borrowing cheaper for businesses and consumers, encouraging loans and spending.
Effect on Money Supply: Banks become more willing to lend, increasing the available money supply.
Effect on Inflation: Increased spending and money in circulation can lead to inflationary pressures as demand rises.
Explain the difference between Open Market Operations (OMO) where the RBI buys securities and where the RBI sells securities.
RBI buys securities:
Injects money into the economy as the RBI pays for the securities.
Increases money supply.
Used to combat deflationary pressures.
RBI sells securities:
Withdraws money from the economy as buyers pay the RBI for the securities.
Decreases money supply.
Used to combat inflationary pressures.
How does Moral Suasion work as a monetary policy tool?
Moral Suasion relies on the central bank’s influence and persuasion to encourage banks to follow certain policies.
This might involve the central bank communicating with the banking sector, urging them to increase or decrease lending in line with policy goals.
It’s a less direct tool compared to others, as it relies on voluntary compliance by banks.
What is the purpose of Selective Credit Controls and Priority Sector Lending?
These tools allow central banks to direct credit towards specific sectors considered important for economic development (e.g., agriculture, small businesses).
They can also be used to curb lending to sectors seen as contributing to inflation.
What is the difference between hawkish and dovish monetary policy stances?
Hawkish: A policy stance focused on fighting inflation. This usually involves raising interest rates, decreasing the money supply, and restricting credit.
Dovish: A policy stance focused on promoting economic growth and employment. This usually involves lowering interest rates, increasing the money supply, and easing credit restrictions.
What are the limitations of monetary policy?
Time Lags: There is often a delay between implementing monetary policy changes and their effects being felt in the economy.
External Factors: Global economic conditions, supply chain disruptions, and unexpected shocks can limit the effectiveness of monetary policy.
Fiscal Policy: Monetary policy needs to be coordinated with government spending and taxation (fiscal policy) for optimal results.
Explain the concept of the Liquidity Trap.
A Liquidity Trap occurs when interest rates are already very low (near zero), and further cuts by the central bank have little impact on increasing borrowing and spending.
This usually happens during severe recessions or periods of deflation.
What is quantitative easing (QE)?
A form of unconventional monetary policy where a central bank purchases large amounts of government bonds or other assets from the market.
This directly injects money into the economy, aiming to lower long-term interest rates and encourage lending even when traditional interest rate cuts are ineffective.
Discuss the potential negative consequences of expansionary monetary policy.
Inflation: Too much money in the economy can lead to excessive price increases.
Asset Bubbles: Cheap credit can fuel unsustainable price increases in assets like stocks or real estate.
Exchange rate instability: Lower interest rates can make a country’s currency less attractive, leading to depreciation.
