Previous Year Question

An expansionist monetary policy seeks to increase the availability of credit and liquidity in the economy and reduce the cost of borrowing. It is generally adopted when economic activity, demand or investment is weak.

The question asks which action the RBI would not undertake.

Statement 1 is consistent with an expansionist policy.

The Statutory Liquidity Ratio, or SLR, is the minimum percentage of a bank’s Net Demand and Time Liabilities that must be maintained in liquid assets such as cash, gold or approved securities.

A reduction in the SLR leaves a comparatively smaller proportion of bank funds locked in mandatory liquid assets. Banks may consequently have more resources available for lending to businesses and households. A reduction in the SLR is therefore consistent with expansionary monetary policy.

Statement 2 is not consistent with an expansionist policy.

Under the Marginal Standing Facility, or MSF, Scheduled Commercial Banks can obtain overnight liquidity from the RBI subject to prescribed conditions.

An increase in the MSF Rate makes emergency overnight borrowing from the RBI more expensive. It can raise the banks’ marginal cost of funds and place upward pressure on market interest rates. This has a restrictive rather than an expansionary effect.

Therefore, the RBI would ordinarily not increase the MSF Rate while adopting an expansionist monetary policy.

Statement 3 is consistent with an expansionist policy.

A reduction in the Repo Rate lowers the cost at which banks obtain short-term funds from the RBI. Under suitable conditions, this reduction may be transmitted to bank lending rates and other market interest rates.

A reduction in the Bank Rate also lowers the general direction of central-bank-related borrowing and penal rates. Lower interest rates may stimulate demand for consumption, housing, working-capital and investment loans.