Monetary Policy measures to Correct Problem of deficient demand and excess demand

Policy ActionMeaningExcess DemandDeficient Demand
Bank RateThe interest rate at which RBI lends money to commercial BanksIncreasedDecreased
Repo RateThe interest rate at which RBI lends money to commercial BanksIncreasedDecreased
Rev Repo RateInterest rate at which commercial banks keep their money with RBIIncreasedDecreased
Open market OperationsBuying and Selling of securities by RBI to control the liquidity in the economySellingBuying
CRR% of deposits that commercial banks needs to keep with RBIIncreasedDecreased
SLR% of deposits which commercial banks needs to keep with themselves in the form of liquid assetsIncreasedDecreased
Margin RequirementsMinimum down payment which borrower needs to make as a % of total loanIncreasedDecreased
Moral SuasionAdvisory instructions by RBI to Commercial banksBe strict while lendingBe Liberal while lending
Credit rationingPrescribed credit limits for different sectors of the economyIncreasedDecreased/Withdrawn

The key element in all the above policy actions is the focus on money supply in the economy. Example – Suppose RBI wants to control the excess demand in the economy then it will increase the Bank rate. The cost of funds for commercial banks will increase. They in turn will increase the lending rate for people. Higher interest rates will reduce the demand for credit. People will get less credit and hence will have less money. This will reduce the aggregate demand.

The other policy actions can similarly be interpreted with focus on increasing money supply if deficient demand to be controlled or focus on decreasing money supply if excess demand is to be controlled.

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