Monetary Policy Stances
| DIFFERENT MONETARY POLICY STANCES OF THE RBI | ||
| Accommodative Stance | Neutral Stance | Calibrated Tightening |
| Accommodative stance means RBI may reduce the policy rates to increase the money supply in the economy. | Neutral stance means the RBI would have the flexibility to either increase or decrease the policy rates by considering the macroeconomic conditions. | Calibrated Tightening stance means the RBI would either keep the rates constant or increase the rates. |
| Under this stance, policy rates normally decrease. | Under this stance, key policy rates would move in either direction. | Under this stance, key policy rates either remain unchanged or increase. Decrease in policy rates is ruled out. |
| Usually, this policy is adopted when there is slowdown in the economy. | Usually, this policy is adopted when the inflation rate is stable. | Usually, this policy is adopted when there are concerns of higher rate of inflation. |
Unconventional Monetary Policy Tools
Zero Interest Rate Policy (ZIRP): This policy was followed in USA from 2008 in the wake of financial crisis to inject money into the economy to promote economic growth. Under this policy, the US Fed Bank provided loans to the banks at almost 0.25% rate of interest. The idea was to transmit lower rate of interest to the corporates and borrowers to spur demand. This was also known as Quantitative Easing. (The Opposite of Quantitative Easing is Fed Tapering)
Negative Interest Rate Policy (NIRP): This policy was followed in developed economies such as Japan, Denmark, Sweden, Switzerland etc. Usually, the banks park their surplus reserves with the Central Bank and earn interest. However, under the NIRP, the banks would be required to pay interest to the central bank if they park their surplus reserves.
The idea here is that the banks should provide loans to the borrowers at cheaper rates instead of parking their surplus reserves with the Central Bank.
Helicopter Money: It is a hypothetical concept put forward by the economist, Milton Friedman. This involves the central bank of the country printing currency notes and distributing it to the people free of cost. The idea here is to promote demand in the economy during recession.
It is different form ZIRP and NIRP, as under these two, the people get loans at cheaper rate which increases the debt liability. But in helicopter money since people receive money free of cost, it does not lead to increase in debt liability.
External Benchmarking
Monetary policy transmission refers to the process through which changes in the policy rates (such as Repo) by the RBI leads to commensurate changes in the rates of Interest of the Banks. As the Repo rate increases, the rate of Interest on the deposits and loans also increases. Similarly, as the repo rate decreases, the rate of interest decreases.
Reasons for Poor Monetary Policy Transmission
Over-dependence on Deposits: The Banks rely more on public deposits rather than on RBI for raising money to give loans. Had the Banks been more dependent on the RBI for the raising money, then changes in the Repo rate would have been easily transmitted into changes in the rate of Interest on loans.
Deposits with higher maturity period: Deposits with maturity of one year and above constitute more than 50% of total deposits. Most of these deposits are fixed-Interest rate deposits (and not floating rate) and hence it becomes difficult for the banks to reduce the rate of Interest on the loans without undertaking losses.
Small savings Schemes: The Government is operating a number of small savings schemes such as PPF, National Savings Certificate (NSC), Kisan Vikas Patra etc. Usually, the interest rates on these savings schemes tend to be higher as compared to rate of Interest on Banks' deposits.
Higher NPAs: The higher NPAs of the Banks accompanied by higher provisioning requirements would reduce the ability of the Banks to offer loans at lower rates of Interest and thus hinders monetary policy transmission.
Opaqueness in calculation of Marginal Cost of Lending rate (MCLR): The MCLR is the minimum rate of interest below which the Banks are not allowed to give loans. The MCLR, which replaced the earlier Base rate regime was introduced in 2016.
The Base rate regime did not consider the Repo rate for the calculation of the minimum rate of interest on the loans offered by the Banks. Hence, changes in the Repo rate did not have much impact on the rate of interest on loans.
This was rectified by the introduction of MCLR, which apart from other parameters also considers the changes in the Repo rate.
However, it is flawed on account of two reasons- Opaqueness and not being solely dependent on Repo rate.
Firstly, despite reduction in the repo rate, the Banks can claim increase in the operational expenses and continue to maintain higher interest rates on loans and hence opaque.
Secondly, the rate of interest on loans also depends on parameters such as rate of interest on new deposits. Hence, despite reduction in repo rate, the interest rates on deposit may continue to be higher leading to higher interest rates on loans.
To address these problems, the RBI has asked the Banks to link all the floating rate loans to any of the 4 External benchmarks.
Benefits
- Unlike MCLR, External benchmark is influenced solely by the policy rates leading to higher efficiency.
- Greater transparency.
Borrowers know the profit margin fixed by various banks and hence can choose accordingly.
Taylor's Rule
This rule suggests as to how the Central Bank in a country should change the interest rates to control inflation or promote Growth. According to this rule,
- Central Bank should increase interest rates when the Inflation is too high or when actual GDP is more than Potential GDP.
- Similarly, Central Bank should reduce the interest rates when Inflation is too low or when the actual GDP is higher than Potential GDP.