UPSC Prelims 2020 Q57: Indian Economy – Monetary Policy & Money Supply
- (a) 1 and 2 only
- (b) 2 only
- (c) 1 and 3 only
- (d) 1, 2 and 3
Answer: (b) 2 only
Explanation
RBI Expansionary Monetary Policy: What RBI Would NOT Do
| Action | In expansionary policy? |
|---|---|
| 1. Cut SLR (Statutory Liquidity Ratio) | YES - do this |
| 2. Increase Marginal Standing Facility (MSF) Rate | NO - do opposite |
| 3. Cut Bank Rate + Repo Rate | YES - do this |
Expansionary policy = increase money supply/credit:
- YES Cut SLR -> banks lend more (less reserves required)
- NO Increase MSF rate -> makes emergency borrowing expensive (contractionary). Would cut MSF.
- YES Cut Bank Rate + Repo -> cheaper bank borrowing
Answer: (b) 2 only - Increasing MSF rate is what RBI would NOT do in expansionary policy.
Why each option is right or wrong
- (a) Incorrect. Incomplete - statement 2 is the key one.
- (b) CORRECT. In expansionary policy, RBI would NOT increase MSF rate; it would cut it. Increasing MSF is contractionary.
- (c) Incorrect. Statements 1 and 3 would be done in expansionary policy.
- (d) Incorrect. All three together is contradictory.
Key point
Expansionary monetary policy toolkit: Cut CRR (Cash Reserve Ratio), cut SLR, cut Repo/Bank Rate, cut MSF. Increasing MSF is contractionary (opposite of expansion).
Remember
If the RBI decides to adopt an expansionary monetary policy, it would NOT increase the Marginal Standing Facility Rate. In expansionary policy, RBI would cut SLR, cut Repo/Bank rates, and CUT (not increase) the MSF rate to make emergency liquidity cheaper for banks.
Common mistakes
- Confusing MSF (emergency rate) with normal repo rate. MSF is HIGHER than repo; used when banks face acute shortage.
- Assuming 'increase rate' always = tightening. For lending rates yes, but context matters (is it emergency rate?).
- Missing the hierarchy - Repo (normal) -> MSF (emergency) -> penalty rate. Changing MSF signals urgency.
Exam tip
RBI's rate corridor: Repo (base rate) < MSF (emergency, higher) < Penalty rate. In expansion, all three shift down. In contraction, all three shift up.
Sources
- RBI - Monetary Policy Framework
- RBI Circulars on Liquidity Management