Context: India’s retail inflation has eased to around 5% in November from October’s 14-month high of 6.2%. This assumes significance ahead of the Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC) meeting in the backdrop of a spike in October’s inflation and a sharp slump in economic growth with GDP rising just 5.4% in the July-September quarter.
Relevance of the Topic: Prelims: Monetary Policy and its Components.
What is Monetary Policy?
- Monetary policy refers to a policy of the Central Bank (Reserve Bank of India) to regulate money supply in the economy.
- It is aimed to achieve certain objectives like Price stability, accelerating economic growth or exchange rate stabilization.
- RBI uses various tools to achieve these objectives. One such tool is Liquid Adjustment Facility (LAF).
Liquid Adjustment Facility (LAF):
- LAF is a facility provided by RBI to scheduled commercial banks to avail of liquidity in case of need or to park excess funds with RBI on an overnight basis against the collateral of government securities. The components of LAF are:
- Repo rate is the interest rate charged by the RBI on overnight loans given to the commercial banks under the Liquidity Adjustment Facility.
- Reverse repo rate is an interest rate given by the RBI to commercial banks when the latter parks one-day deposits with the RBI.
These rates are referred to as key policy rates.
| Expansionary Monetary Policy | Contractionary Monetary Policy | |
| Action | To infuse liquid into the market | To absorb liquid from the market |
| Tool | Reduce policy rates | Increase policy rates |
| Goal | Accelerate economic growth | Inflation control |