Monetary Policy: Instruments and Transmission Mechanism

TOPIC CLASSIFICATION

Subject: Indian Economy Sub-area: Monetary Policy - RBI, Instruments, Transmission Difficulty: Medium-Hard Weightage: High (2-3 Prelims + Mains question per year)

EXAMINER REASONING

1. Trap: Believing the RBI has full control over all monetary instruments - effective transmission depends on banking system, market conditions, and fiscal policy alignment.
2. Most confused: Quantitative vs Qualitative instruments - CRR/SLR/Repo (quantitative) vs Margin requirements/Moral suasion (qualitative).
3. Key anchor: Reserve Bank of India Act, 1934 - Section 45ZB established the Monetary Policy Committee (MPC).
4. Current affairs hook: MPC maintained repo rate at 6.5% through 2024 into 2025 amidst sticky inflation; CRR cut to 4% (Dec 2024); debate on flexible inflation targeting (FIT) framework.
5. Mains hinge: "The flexible inflation targeting framework has anchored inflation expectations but at the cost of growth. Critically examine India's monetary policy experience since 2016."

Core Concept

Monetary Policy Framework

• Flexible Inflation Targeting (FIT): Adopted 2016 (Amended RBI Act, 1934)
• Inflation Target: 4% CPI (± 2%) - i.e., 2%-6% tolerance band
• Failure threshold: If inflation is outside 2-6% for 3 consecutive quarters → RBI must report to Govt
• Monetary Policy Committee (MPC): 6 members - 3 from RBI...