Explained: Why RBI’s monetary policy matters

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  1. The Monetary Policy Committee of the RBI has decided to cut the repo rate by 35 basis points to 5.4%.
  2. The monetary policy is important as any economic activity which is measured by GDP happens by (a) private individuals and households spend money on consumption (b)the government spends on its agenda (c)private sector investment and (d)net exports.
  3. However,any spending decision taken by any of these entities need to know the cost of money which is answered by monetary policy.
  4. Monetary policy is the process by which the Reserve Bank of India(RBI) manages money supply in the economy.The objectives of monetary policy include ensuring inflation targeting and price stability, full employment and stable economic growth.
  5. The monetary policy instruments used by RBI are Repo and Reverse repo.Repo rate is the rate at which the RBI lends money to commercial banks.On the other hand,Reverse repo rate is the rate at which the RBI borrows money from commercial banks within the country.
  6. Further,Investments also depends on the real interest rate.The real interest rate is the difference between the repo rate and retail inflation.
  7. However,real interest rates in India have been rising and that is one of the reasons why investments are not happening.But the RBI’s move would reduce the real interest rate and hopefully attracts more investment.