EXAM
EXAM
Description
The Reserve Bank of India (RBI) manages the economy through monetary policy, which controls money supply, borrowing rates, inflation, and overall economic activity. There are two main types:
- Expansionary Monetary Policy
- Contractionary Monetary Policy
What is Expansionary Monetary Policy?
Definition: Expansionary monetary policy is applied when the economy is slow, unemployment is high, or spending is low.
Objective: Increase the flow of money, encourage borrowing, and stimulate economic growth.
How It Works: The central bank supports the economy by:
- Reducing Repo Rate (cheaper loans for banks)
- Lowering Reverse Repo Rate (banks deposit less money with RBI)
- Cutting Cash Reserve Ratio (CRR) (banks keep less cash with RBI)
- Buying government securities (injecting money into the system)
- Giving more loans to banks
Impact:
- Loan rates become lower
- Consumers spend more
- Businesses invest more
- Employment rises
- Economic activity grows
Example: During the COVID-19 pandemic, RBI reduced repo and reverse repo rates to boost borrowing and economic recovery.
What is Contractionary Monetary Policy?
Definition: Contractionary monetary policy is used when prices rise too fast (high inflation) or the economy grows too quickly.
Objective: Reduce the money supply, make borrowing costlier, and control inflation.
How It Works: The central bank limits money circulation by:
- Increasing Repo Rate (loans become costlier)
- Raising Reverse Repo Rate (banks deposit more money with RBI)
- Increasing CRR (banks keep more money with RBI)
- Selling government securities (removing money from the system)
Impact:
- Loan rates rise
- Consumer spending decreases
- Business investment slows
- Economic growth reduces
- Inflation is checked
Example: When inflation crossed 7%, RBI increased the repo rate several times to reduce money supply.
Key Differences Between Expansionary and Contractionary Policies
Summary:
- Expansionary Policy: Adds money to the system, lowers borrowing costs, boosts spending and investment.
- Contractionary Policy: Reduces money supply, raises borrowing costs, slows spending, and keeps inflation in check.
Understanding these policies is essential for UPSC, banking exams, and general economic knowledge.
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