What is monetary policy?

Monetary Policy is formulated by the Reserve Bank of India (RBI) relating to the financial economics of the country. The main objective involves the measures taken to regulate the supply of money, availability, and cost of credit in the economy. It also oversees the distribution of credit among users and the borrowing and lending rates of interest. Since the policy controls the rate of interest and inflation, it can affect the savings and investment of the people. The policy also aims to substitute imports and increase exports and thus helps improve the condition of the balance of payments.

This policy is an evident tool to control the rise and fall of business cycles by managing the credit to control the supply of money.

The monetary policy committee (MPC) can increase the money supply by lowering the reserve requirements for banks, which allows them to lend more money. Conversely, by raising the banks' reserve requirements, the MPC can decrease the size of the money supply.

Monetary authorities can use it to structure a balance between the demand and supply of goods and services. As the MPC can reduce or increase the interest rate, corporates as well as small and medium enterprises can use it to their benefit.

Also, the RBI can affect the money supply by conducting open market operations, which affects the funds rate. In open operations, the RBI buys and sells government securities in the open market. If the RBI wants to increase the money supply, it buys government bonds. This supplies the securities dealers who sell the bonds with cash, increasing the overall money supply.

On the other hand, if the central bank wants to decrease the money supply, it sells bonds from its account, thus taking in cash and removing money from the economic system. Adjusting the funds rate is a heavily anticipated economic event.