UPSC Prelims 2020 Question:

If the RBI decides to adopt an expansionist monetary policy, which of the following would it not do?

1) Cut and optimize the Statutory Liquidity Ratio

2) Increase the Marginal Standing Facility Rate

3) Cut the Bank Rate and Repo Rate

Select the correct answer using the code given below:

Explanation

• Expansionary monetary policy is when the Reserve Bank of India (RBI) uses its tools to stimulate the economy. It can result in increase in money supply, lower interest rates, and increase demand. It boosts economic growth. It lowers the value of the currency, thereby decreasing the exchange rate. It is the opposite of contractionary monetary policy.
  
  
• Statutory Liquidity Ratio (SLR) has to be maintained by every bank in India. It is maintained in the form of cash, gold reserves, government bonds and other Reserve Bank of India- approved securities. When SLR is reduced, it will leave more credit to be distributed. SLR is reduced to increase money supply and stimulate demand. So, point 1 is not correct.
  
  
• Marginal Standing Facility (MSF) Rate is the penal rate at which banks can borrow on an overnight basis from the Reserve Bank by pledging government securities. It is used against an unanticipated liquidity shocks to the banking system. A rise in MSF will increase the cost for banks for borrowing money from RBI. Further, it will leave banks with less money to be distributed as credit. It is used by RBI to reduce money supply. It is decreased when RBI follows an expansionary monetary policy. So, point 2 is correct.
  
  
• Repo Rate is the interest rate at which the RBI provides liquidity to commercial banks under the Liquidity Adjustment Facility (LAF) against the collateral of government and other approved securities. Bank rate is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers. A cut in repo rate and bank rate will leave commercial banks with more money to be distributed as loans. It will lead to an increase in money supply. Both repo rate and bank rate are reduced during an expansionary monetary policy. So, point 3 is not correct.
  
  

Therefore, option (2) is the answer.

Relevance: An expansionary monetary policy was followed by the Government after COVID-19 lockdown in 2020.

Subject: Economics | Money and Banking