Question

To implement a contractionary monetary policy, RBI should not do which of the following?

A. Increase the Statutory Liquidity Ratio.
B. Decrease the Marginal Standing Facility Rate.
C. Cut the Bank Rate and Repo Rate.

How many of the above statements is/are correct?

1. A and B
2. A only
3. B and C
4. A, B, and C

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Answer 1

Answer: (3) B and C

Explanation:

Contractionary monetary policy is intended to reduce the money supply in the economy to control inflation. The Reserve Bank of India (RBI) implements this by taking certain measures:

• A. Increase the Statutory Liquidity Ratio (SLR):

  • Incorrect: Increasing the SLR is actually a tool for contractionary policy. It requires banks to hold a higher proportion of their deposits in liquid assets, reducing the funds available for lending. Thus, this action supports contractionary policy, and it is not something the RBI should "not" do.

• B. Decrease the Marginal Standing Facility (MSF) Rate:

  • Correct: Decreasing the MSF rate would make it cheaper for banks to borrow from the RBI in case of emergencies, which can increase the money supply. Therefore, this is not aligned with a contractionary policy, and the RBI should avoid this.

• C. Cut the Bank Rate and Repo Rate:

  • Correct: Lowering the Bank Rate and Repo Rate reduces the cost of borrowing for banks, which can lead to increased lending and, consequently, an increased money supply. This is contrary to contractionary policy objectives, so the RBI should avoid cutting these rates.

Conclusion:

Statements B and C are actions that the RBI should not do when implementing a contractionary monetary policy. Therefore, the correct answer is (3) B and C.