MONETARY POLICY COMMITTEE

Subject: Economy

Context: Central bank believes monetary policy needs to remain accommodative despite inflationary pressures, according to the minutes of the monetary policy committee.

Reserve Bank of India (RBI) left interest rates unchanged at that meeting, as expected.

Concept:

• The MPC is a statutory and institutionalized framework under the RBI Act, 1934, for maintaining price stability, while keeping in mind the objective of growth.
• The MPC determines the policy interest rate (repo rate) required to achieve the inflation target (4%).
• The Governor of RBI is ex-officio Chairman of the MPC.
• The Monetary Policy Report is published by the Monetary Policy Committee (MPC) of RBI.

Link between Growth, Inflation and Interest rates:

• In a fast-growing economy, in comes go up quickly and more and more people have the money to buy the existing bunch of goods.
• As more and more money chases the existing set of goods, prices of such goods rise. In other words, inflation (which is nothing but the rate of increase in prices) increases.
• To contain inflation, a country’s central bank typically increases the interest rates in the economy. By doing so, it incentivises people to spend less and save more because saving becomes more profitable as interest rates go up.
• However, when growth contracts, people’s incomes hit. As a result, less and less money is chasing the same quantity of goods. This results in either the inflation rate decelerating or it actually contracts (also called deflation).
• In such situations, a central bank decreases interest rates so as to incentivises pending and by that route boost economic activity in the economy.
• In the current Monetary Policy, RBI has not raised the interest rates even when retail inflation is high because RBI is facing an odd situation at present: GDP is contracting even as inflation is rising.
• This is happening because the pandemic has reduced demand, on the one hand, and disrupted supply on the other. As a result falling growth and rising inflation are happening at the same time.