Expansionary monetary policy

Also called: Easy money policy, Cheap money policy, Monetary easing · Topic: Banking, Credit Creation and Monetary Policy · NCERT: Beyond NCERT

Meaning

Expansionary monetary policy is when the central bank increases the money supply and makes credit (loans) cheaper. It does this by cutting policy rates such as the repo rate, or by adding liquidity (ready cash in the banking system) through tools like a CRR cut or OMO purchases. The aim is to raise demand, investment and growth.

• It matters because it is the RBI's main tool to support a slowing economy, as it did during the COVID shock.
• But it must be balanced against the RBI's main legal goal, which is price stability.

Explanation

How it works: the chain of effects

• Repo rate cut (the repo rate is the interest rate at which the RBI lends to banks for a short time)
• Banks borrow from the RBI more cheaply.
• Banks cut the interest rates on their loans.

• People and firms borrow more and spend more, so demand rises.

• Liquidity injection (putting more cash into banks)

• Banks have more money to lend.
• Competition to lend pushes loan rates down.

• Credit and money supply grow.

• Operating target: the RBI tries to keep the weighted average call rate (WACR) close to the repo rate [4]. The WACR is the average rate at which banks lend to each other overnight.

• During easing, the RBI adds liquidity so that the WACR falls along with the lower repo rate [4].

The tools used for easing

All of these are quantitative tools. They change the total amount and cost of credit in the whole economy and do not target any one sector.

Tool	Expansionary move	Effect
Repo rate	Cut	Cheaper borrowing for banks
CRR (Cash Reserve Ratio)	Cut	Banks keep less idle cash with the RBI, so the money multiplier rises
SLR (Statutory Liquidity Ratio)	Cut	More of a bank's funds become free to lend
OMO (open market operations)	RBI buys government bonds	Cash goes to banks as a durable (long-lasting) injection
SDF / reverse repo	Cut	Parking money with the RBI earns less, so banks prefer to lend

• Basis point (bp): 1 bp = 0.01 percentage point, so 100 bps = 1 percentage point.
• Repo vs OMO: a repo injection is temporary (overnight, 7-day or 14-day) and reverses at the end of the term. An outright OMO purchase changes liquidity permanently [4].

Worked examples

• Repo cut and a bank's borrowing cost: a bank borrows ₹1,000 crore overnight.
• At 6.5%: interest = 1,000 × 0.065 ÷ 365 ≈ ₹0.178 crore ≈ ₹17.8 lakh.
• At 5.25%: interest = 1,000 × 0.0525 ÷ 365 ≈ ₹0.144 crore ≈ ₹14.4 lakh.

• The 125 bp cut saves the bank about ₹3.4 lakh a night on the same loan.

• CRR cut and the money multiplier: simple money multiplier = 1 / CRR, ignoring SLR and cash held by the public.

• CRR 4% → multiplier = 1/0.04 = 25. So ₹100 of fresh reserves supports ₹2,500 of deposits.

• CRR 3% → multiplier = 1/0.03 ≈ 33.3. So the same ₹100 supports about ₹3,333.

• CRR cut and one bank: take a bank with NDTL of ₹950 crore. NDTL (Net Demand and Time Liabilities) is the base on which CRR is calculated.

• At 4% CRR, it must keep ₹38 crore with the RBI.
• At 3% CRR, it must keep ₹28.5 crore.
• About ₹9.5 crore is freed for lending.

What decides how strong the effect is

• Transmission: how much of the rate cut banks actually pass on to borrowers.
• Demand for loans: if firms and households are pessimistic, cheap credit may not be used.
• Inflation: if prices are already high, easing can push them higher. That limits how far the RBI can cut.

In India

• Institution: the Reserve Bank of India (RBI), set up in 1935, runs monetary policy.
• Law: the preamble of the RBI Act, amended in 2016, sets the objective: "to maintain price stability while keeping in mind the objective of growth" [4]. Growth is a secondary aim, so easing is allowed only within the inflation limits.
• Inflation target (s.45ZA): CPI 4%, with a band from 2% to 6%. The Central Government fixes it with the RBI every 5 years. It was renewed on 25 March 2026 for 1 April 2026 to 31 March 2031 [4].
• Who decides the repo rate (s.45ZB): the 6-member Monetary Policy Committee (MPC), chaired by the RBI Governor, with 3 external members [4].
• Easing episodes:
• 2019-20 easing: the repo rate was cut to 4% by May 2020 because of the COVID shock.
• 2025 easing cycle: the repo rate was cut from 6.5% to 5.25% by December 2025, a total cut of 125 bps.

• CRR cut in 2025: announced in June 2025, it lowered the CRR from 4% to 3% of NDTL in four steps of 25 bps. The last step took effect from 29 November 2025 [3].

• Latest (August 2026): the MPC voted unanimously to keep the repo rate at 5.25% with a neutral stance [1]. It had also held the rate at its April and June 2026 meetings [2]. So the easing cycle has paused, not reversed.

• Corridor, August 2026 [1]: SDF 5.00% < Repo 5.25% < MSF = Bank rate 5.50%.

Don't confuse with

• Contractionary monetary policy: the opposite. The RBI raises rates or takes liquidity out to control inflation. Example: the repo rate went from 4% to 6.5% (+250 bps) between May 2022 and February 2023.
• Expansionary fiscal policy: the government, not the RBI, raises spending or cuts taxes through the Budget. Monetary easing works through interest rates and credit.
• Qualitative (selective) credit tools: tools like margin requirements and moral suasion direct credit towards or away from particular sectors. Expansionary policy uses quantitative tools, which affect credit across the whole economy.
• Neutral stance: a stance is the RBI's signal about future rate moves. Holding the rate at 5.25% with a neutral stance in August 2026 [1] is not easing, even though rates are lower than in 2024.

Prelims Hooks

• Expansionary tools: cut repo, CRR, SLR or SDF, or buy bonds through OMO. A trap option is "OMO sale", which absorbs liquidity and is contractionary.
• CRR comes from RBI Act s.42 and is kept with the RBI, earning no interest. SLR comes from Banking Regulation Act s.24 and is kept by the bank itself. Both are calculated on NDTL, not on total deposits.
• Money multiplier = 1/CRR. The 2025 cut from 4% to 3% raised it from 25 to about 33.3. The 3% level took effect on 29 November 2025 [3].
• The repo rate is set by the MPC (s.45ZB), not by the Governor alone. The operating target is the WACR, not the repo rate itself [4].
• Outright OMO purchase gives durable (long-lasting) liquidity. Repo gives temporary liquidity for overnight, 7 or 14 days.
• As of August 2026, the repo rate is 5.25% with a neutral stance, after 125 bps of cuts in 2025 [1].

Mains Points

• Growth vs inflation trade-off: the RBI Act puts price stability first and growth second [4].
• The RBI raised rates by 250 bps in 2022-23, cut them by 125 bps in 2025, and then held at 5.25% in 2026 [1][2].

• Easing too early can bring inflation back. Holding rates high for too long can slow growth.

• Weak transmission: a repo cut works only if banks lower their loan rates.

• Banks have already promised fixed rates to depositors, so they are slow to cut loan rates.

• That is why the RBI used the 100 bp CRR cut in 2025 along with the rate cuts. It gave banks cheap funds to lend [3].

• Limits of monetary easing and the institutional frame: cheap credit cannot create demand when confidence is low, so it often needs support from fiscal policy (GS-III).

• The rule-based MPC framework, with a legal definition of target "failure", keeps easing decisions accountable and separate from fiscal pressure (GS-II, statutory bodies) [4].

Related concepts

• Monetary policy
• Contractionary monetary policy
• Quantitative tools of monetary policy
• Cash Reserve Ratio
• Net Demand and Time Liabilities
• Statutory Liquidity Ratio
• Bank rate
• Open market operations
• Outright open market operations
• Repo rate

Read more

• Monetary policy and its quantitative instruments