In May 2016, the RBI Act was amended to provide a legislative mandate to the central bank to operate the country’s monetary policy framework.
The framework aims at setting the policy (repo) rate based on an assessment of the current and evolving macroeconomic situation, and modulation of liquidity conditions to anchor money market rates at or around the repo rate.
Reason for Repo Rate as Policy Rate:
Repo rate changes transmit through the money marketto the entire financial system, which, in turn, influences aggregate demand.
Thus, it is a key determinant of inflation and growth.
What is Monetary Policy Committee?
Under Section 45ZB of the amended (in 2016) RBI Act, 1934, the central government is empowered to constitute a six-member Monetary Policy Committee (MPC).
Further, Section 45ZB lays down that “the Monetary Policy Committee shall determine the Policy Rate required to achieve the inflation target”.
The decision of the Monetary Policy Committee shall be binding on the Bank.
Section 45ZB says the MPC shall consist of 6 members:
RBI Governor as its ex officio chairperson,
Deputy Governor in charge of monetary policy,
An officer of the Bank to be nominated by the Central Board,
Three persons to be appointed by the central government.
This category of appointments must be from “persons of ability, integrity and standing, having knowledge and experience in the field of economics or banking or finance or monetary policy”.