Monetary Policy Tools

To control inflation, the Reserve Bank of India needs to increase the cost of fund or reduce the supply of money with the help of tools which are divided mainly into two categories – Quantitative and Qualitative tools.

Quantitative tools : These tools impact the money supply in the economy, including sectors such as manufacturing, housing, etc.

Reverse Ratio : Banks keep aside a certain percentage of cash reserves or RBI approved assets. There are two types of reserve ratio:

Cash Reserve Ratio (CRR) : Banks set aside this portion in cash with the RBI. The bank cannot lend this amount to anyone or earn a profit or interest rate on CRR.

Statutory Liquidity Ratio (SLR) : This portion is set aside by the banks in the form of liquid assets such as gold or RBI approved securities such as government securities. Banks earn interest on these securities, but it’s very low.

Open Market Operations : The RBI buys and sells government securities in the open market, also referred to as Open Market Operations to control the supply of money.

When the RBI sells government securities, the liquidity is sucked from the market, and buying securities provides liquidity, which helps to control inflation. The main aim of the open market operation is to keep a check on temporary liquidity mismatches in the market, which happens due to the inflow of foreign capital.

Qualitative tools :These tools affect the money supply of a specific sector of the economy.

Margin requirements : The RBI mentions a certain margin against collateral. When the RBI raises the margin requirements, customers will be able to borrow less and vice-versa.

Selective credit control : Through this method, RBI avoids lending to speculative businesses or selective industries.

Moral suasion : With the help of this tool, the central bank persuades other banks to keep money in government securities and not in any other sectors.