Policy Rates-Cut.Raise.Hold.

HEADLINE:

  • The Reserve Bank of India in its Third Bi-monthly Monetary Policy Statement for 2019-20 on Aug 07, 2019 announced a rate cut of 35 basis points(0.35%).
  • Federal Reserve on Jul 31,2019 lowered interest rates by 25 basis points(0.25%)

DISSECTION:

The two headlines above indicate that there has been a rate cut by the respective central banks of India and US. So, what is a rate cut? What role does it play in a country’s economy? The rates- policy rate or interest rate is a monetary policy tool mostly under the authority of a country’s central bank either through legal backing or mandate. A policy rate determines the availability and cost of money and credit in the financial system. The various forms of policy rate include Repo (repurchase) rate, Reverse Repo, Marginal Standing Facility Rate and Reserve Ratios(Cash Reserve and Statutory Liquidity). These policy rates assist in a country’s economy to contract or expand. For instance, a cut in the interest rate boosts economic activity through fostering credit expansion. While a rise in interest rate is commonly aimed at curbing inflation, currency depreciation and excessive credit growth.Finally, the central banks may choose to maintain the status quo by keeping the rates unchanged(hold).

NOTABLE PHRASES:

A monetary policymaker can be perceived as Hawk or Dove depending on the policy rate. A hawkish policy primarily favors high interest rate to arrest inflation while a dovish policy involves low interest rates to boost economic growth.