Question

Read the passage given below and answer the questions that follow.

The Monetary Policy Committee (MPC) increased the repo rate, at which the RBI lends short-term funds to commercial banks, from 6.25 percent to 6.50 percent. This increase in the repo rate is based on the increase in the key rate by 250 bps. The Committee also decided to continue the withdrawal of money supply in the economy.

1. Which function of the central bank is hinted at in the passage given above?  (1)
2. In which situation does central bank adopt the measure given in the above passage? (1)
3. Explain any two monetary measures that can be used to accomplish a similar objective, other than the one given in the above passage. (4)
4. Differentiate between Reserve Bank of India and Commercial banks by giving any two points. (2)

Answer 1

1. The Central Bank's function, as mentioned in the paragraph, is "Monetary Policy Implementation." The RBI's decision to raise the repo rate is a monetary policy action designed to control the economy's money supply.
2. In order to control inflation, the Central Bank usually raises the repo rate. It attempts to reduce inflationary pressures by increasing the cost of borrowing, thereby reducing the money supply.
3. Two other monetary measures that can be used to achieve an analogous objective for controlling the money supply and inflation are:
   1. Increasing the Cash Reserve Ratio (CRR): The CRR is the percentage of a bank's total deposits that must be held in reserve at the Central Bank. By raising the CRR, banks will have less money to lend to clients, thus contributing to a reduction in the economy's money supply.
   2. Open Market Operations (OMO): This refers to the purchase or sale of government securities on the open market. To limit the money supply, the central bank can sell government securities, withdrawing liquidity from the banking sector.
4. The Reserve Bank of India (RBI) and Commercial Banks differ in several ways:

	Reserve Bank of India (RBI)	Commercial Bank
Basis function	The RBI acts as the central bank of India and is responsible for regulating the monetary system of the country. It issues currency, maintains foreign exchange reserves and regulates the banking system.	Commercial banks are financial institutions that accept deposits, provide loans and offer various financial services to the public.
Role in Monetary Policy	The RBI is responsible for formulating and implementing India’s monetary policy. It uses various tools to control inflation and stabilise the currency.	Commercial banks are entities affected by monetary policy; they do not set it. They follow the guidelines and regulations set forth by the RBI.