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MONETARY POLICY

Meaning of Monetary Policy
Monetary Policy of India is formulated and executed by Reserve Bank
of India to achieve specific objectives
...
It refers to the policy measures
undertaken by the government or the central bank to influence the
availability, cost and use of money and credit with the help of monetary
techniques to achieve specific objectives
...
e
...

The techniques of monetary policy are the same as the techniques of
credit control at the disposal of the central bank
...
R
...
Kent defines
monetary policy as the management of the expansion and contraction of the
volume of money in circulation for the explicit purpose of attaining a specific
objective such as full employment
...
J
...
”

▪

In the words of D
...
Rowan, “The monetary policy is defined as
discretionary action undertaken by the authorities designed to
influence (a) the supply of money, (b) cost of money or rate of interest
and (c) the availability of money
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It involves
the management of money and credit for the furtherance of the general
economic policy of the government to achieve the predetermined objectives
...
Different objectives

clash with each other and there is a problem of selecting a right objective for
the monetary policy of a country
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Types of Monetary Policy
There are three common types of monetary policy
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Expansionary Monetary Policy
2
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Unconventional Monetary Policy
1
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It involves
increasing the money supply and lowering the interest rates
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The increased economic activity leads to more employment
opportunities

thus

decreasing

unemployment
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It is also
known as Easy Money Policy or Loose Money Policy as central banks seeks
to increase the money supply by lowering the interest rates
...
Contractionary Monetary Policy
Contraction monetary policy is the monetary policy which is used to
fight the inflation in economy
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As reduction in money supply increases the
interest rates, the borrowers will be reluctant to borrow the money due to
higher borrowing cost which ultimately reduces the economic activity
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It is also known as tight money policy as central banks seeks to reduce the
money supply by restricting credit by increasing interest rates
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Unconventional Monetary Policy
Unconventional monetary policy is pursued by central banks when
their traditional instruments of monetary policy cease to achieve their goals
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Objectives of Monetary Policy
According to RBI Governor Dr
...
Subba Rao, “The objectives of monetary
policy in India are price stability and growth
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” Following are the main objectives of monetary
policy:
i
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Monetary policy is farmed to regulate the money
supply in the economy by credit expansion or credit contraction
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By credit contraction (giving less loans) money supply can

ii
...


be decreased
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In other words, monetary policy
aimed at expanding and contracting money supply according to the
needs of the economy
To Attain Price Stability:
Another major objective of monetary policy in India is to maintain
price stability in the country
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Price
level, is affected by money supply
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To promote Economic Growth:
An important objective of monetary policy is to make available
necessary supply of money and credit for the economic growth of the
country
...
iv
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Higher rates of interest promote saving and investment
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To Control Business Cycles:
Boom and depression are the main phases of business cycle
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In period of
boom, credit is contracted, so as to reduce money supply and thus
check inflation
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v
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To Manage Aggregate Demand:
Monetary authority tries to keep the aggregate demand in balance
with aggregate supply of goods and services
...
Because of low interest rate, more people take loan to
buy goods and services and hence aggregate demand increases and

vi
...

vii
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Priority sector includes
agriculture, small- scale industry, weaker sections of society, etc
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To Promote Employment:
By providing concessional loans to productive sectors, small and
medium entrepreneurs, special loan schemes for unemployed youth,
monetary policy promotes employment
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To Develop Infrastructure:

x
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It provides
concessional funds for developing infrastructure
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RBI has
expanded banking to all parts of the country
...
Besides it, government
has also set up cooperative banks and regional rural banks
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Quantitative, general or indirect (CRR, SLR, Open Market
Operations, Bank Rate, Repo Rate, Reverse Repo Rate)
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Qualitative, selective or direct (change in the margin money, direct
action, moral suasion)
These both methods affect the level of aggregate demand through the
supply of money, cost of money and availability of credit
...
Policy instruments are meant to regulate the overall level of
credit in the economy through commercial banks
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They include changing margin
requirements and regulation of consumer credit
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Bank Rate Policy:
The bank rate is the minimum lending rate of the central bank at
which it rediscounts first class bills of exchange and government
securities held by the commercial banks
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There is contraction of credit and prices are
checked from rising further
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It is cheap to borrow from the central bank on the part of
commercial banks
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Businessmen are encouraged to borrow more
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government = money supply ^ = sell bonds = reduction in money supply = (buy bonds) = money supply

b
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If government wants to reduce money supply, it issues these
bonds
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Similarly, to increase the money supply,
the government sells these bonds thereby increasing the monetary base
of the economy
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Open market operations refer to sale and purchase of securities
in the money market by the central bank of the country
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The reserves of commercial banks are reduced and they are
not in a position to lend more to the business community or general
public
...
Contrariwise, when recessionary forces start in the economy,
the central bank buys securities
...
It
further raises Investment, output, employment, income and demand in
the economy hence the fall in price is checked
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Cash Reserve Ratio (CRR)
It refers to the cash which banks have to maintain with the
Reserve Bank of India as percentage of Net Demand and Time Liabilities
(NDTL)
...
Therefore it reduces their deposit
available for credit and they lend less which affect their profitability and
also reduces the money supply in economy
...
Statutory Liquidity Ratio (SLR)
Apart from CRR, the banks in India are required to maintain
liquid assets in the form of gold, cash and approved securities
...


e
...

•

Repo Rate: It is the interest rate at which the Reserve Bank provides
overnight liquidity to banks against the collateral of government and
other approved securities under the liquidity adjustment facility
(L

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