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HPAS MainsGeneral Studies Paper IIndian EconomyPractice question

Monetary Measures to Curb Inflation

Explain two monetary measures to curb rising inflation.

Explain~250 words2 min readeasy
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Introduce the statutory mandate of the Reserve Bank of India to maintain price stability under the Flexible Inflation Targeting framework. Detail two primary quantitative monetary policy instruments—Repo Rate and Cash Reserve Ratio—explaining their operational mechanism in subduing inflation. Conclude with a brief synthesis on liquidity management and growth balance.

Model answer

206 words

Introduction

Under the Flexible Inflation Targeting (FIT) framework mandated by the RBI Act, 1934, the Monetary Policy Committee (MPC) is tasked with maintaining Consumer Price Index (CPI) inflation within a target band of 4% (±2%). When inflation pressures rise, the central bank deploys contractionary monetary policy measures to absorb excess liquidity and suppress aggregate demand.

Key Monetary Measures

  • Repo Rate Revision under the Liquidity Adjustment Facility (LAF): The repo rate is the policy rate at which the RBI lends short-term funds to commercial banks against government securities. Raising the repo rate increases the cost of funds for banks, prompting them to increase their External Benchmark Lending Rates (EBLR). Higher borrowing costs discourage business investments and retail consumption, shrinking the money multiplier and curbing demand-pull inflation.
  • Cash Reserve Ratio (CRR) Adjustment: CRR refers to the mandatory proportion of Net Demand and Time Liabilities (NDTL) that commercial banks must maintain as liquid cash with the RBI. Hiking the CRR directly impounds systemic primary liquidity, leaving banks with fewer loanable funds. This curtailment of credit supply reduces overall money circulation in the economy.

Conclusion

By tightening quantitative tools like the Repo Rate and CRR, the central bank effectively drains excess liquidity and anchors inflation expectations without severely undermining medium-term economic growth.

Key facts to remember

definition
Flexible Inflation Targeting (FIT)

A monetary policy framework adopted under Section 45ZA of the RBI Act, 1934, mandating the central bank to maintain CPI inflation at 4% with an allowable tolerance band of +/- 2%.

scheme
Liquidity Adjustment Facility (LAF)

A facility implemented by the Reserve Bank of India allowing commercial banks to borrow or lend money on a short-term basis via repo and reverse repo agreements to manage daily liquidity mismatches.

Frequently asked questions

How does raising the repo rate help control inflation?

A hike in the repo rate raises borrowing costs for commercial banks, which in turn increase lending rates for consumers and businesses. This reduces credit uptake, slows consumer spending, and dampens overall aggregate demand.

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