Monetary Measures to Control the Trade Cycle
Monetary policy is used by the central bank (like the RBI) to stabilize the economy by
influencing money supply, credit availability, and interest rates.
1. Bank Rate Policy
Bank Rate is the rate at which the central bank lends money to commercial banks.
● During Boom:
Central bank raises the bank rate
→ Borrowing becomes costlier
→ Credit contracts
→ Demand and inflation reduce
● During Depression:
Central bank lowers the bank rate
→ Cheaper borrowing
→ Credit expands
→ Investment and demand increase
2. Open Market Operations (OMO)
Buying and selling of government securities in the open market by the central bank.
● During Boom:
Central bank sells securities
→ Absorbs excess money
→ Reduces credit availability
● During Depression:
Central bank buys securities
→ Injects money into the system
→ Increases credit and demand
3. Cash Reserve Ratio (CRR)
CRR is the percentage of deposits that banks must keep with the central bank.
● During Boom:
Central bank increases CRR
→ Less money left with banks
→ Controls inflation
● During Depression:
Central bank reduces CRR
→ More funds available to lend
→ Stimulates investment
4. Statutory Liquidity Ratio (SLR)
SLR is the minimum percentage of deposits that banks must maintain in the form of
gold, cash, or approved securities.
● During Boom:
Central bank raises SLR
→ Reduces lending power
→ Controls excess demand
● During Depression:
Central bank lowers SLR
→ Encourages lending and investment
5. Repo and Reverse Repo Rates
● Repo Rate: Rate at which banks borrow from the central bank.
● Reverse Repo Rate: Rate at which banks deposit surplus funds with the central
bank.
● During Boom:
Increase Repo Rate → Costly borrowing → Lower money supply
Increase Reverse Repo → Attracts surplus funds from banks
● During Depression:
Decrease Repo Rate → Cheaper loans → Encourages credit flow
Decrease Reverse Repo → Banks lend more to the public
6. Selective Credit Controls
Controls on how banks issue credit, especially to speculative or non-productive sectors.
● Example: Limiting loans for luxury goods or speculative stock investments during
inflationary phases.
Conclusion:
Monetary measures are powerful tools to stabilize the economy during different phases of
the trade cycle.
● Contractionary policies (higher rates, CRR, SLR) are used during booms.
● Expansionary policies (lower rates, open market purchases) are used during
depressions.
