The objective of monetary policy is to achieve the desired expansion of economy by facilitating the availability of money supply needed for the expansion. The role of formulating monetary policy in India is performed by Reserve Bank of India. It is aimed at ensuring the availability required money supply for all the legitimate economic activities while it should not be available so as to create inflationary pressure.
The primary aim of monetary policy in India is to maintain price stability while keeping in mind the objective of economic growth.
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There are three common types of monetary policy. These are:
Expansionary monetary policy is the monetary policy which seeks to increase aggregate demand and economic growth in the economy. It involves increasing the money supply and lowering the interest rates. The lower interest rate encourages the borrowers to buy more which increases the economic activity. The increased economic activity leads to more employment opportunities thus decreasing unemployment. It also increases the inflation as more money is available to buy goods and services.
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.
Contraction monetary policy is the monetary policy which is used to fight the inflation in economy. It involves decreasing the money supply and increasing the interest rates. 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. It leads to decrease in inflation, increase in unemployment and slowdown in economy.
It is also known as tight money policy as central banks seeks to reduce the money supply by restricting credit by increasing interest rates.
Unconventional monetary policy is pursued by central banks when their traditional instruments of monetary policy cease to achieve their goals. The one such unconventional monetary policy was employed us United States after the financial crisis of 2007 in the form Quantitative Easing (QE).
The Reserve Bank of India employs various instruments of monetary policy in India to achieve the objectives of price stability and higher economic growth. Some of the important instrument or tools of monetary policy in India are:
It is the process of buying and selling of government securities, bond or Treasury Bills (T-Bills) to regulate the money supply in economy. If government wants to reduce money supply, it issues these bonds. The money is consumed to buy these bonds thus it reduced the monetary base of the economy. Similarly to increase the money supply, the government sells these bonds thereby increasing the monetary base of the economy. In India, the open market operations are conducted by Reserve Bank of India through its core banking solution e-Kuber.
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). An increase in CRR makes it mandatory for banks to hold large portion of their deposits with the RBI. Therefore it reduces their deposit available for credit and they lend less which affect their profitability and also reduces the money supply in economy.
Apart from CRR, the banks in India are required to maintain liquid assets in the form of gold, cash and approved securities. The increase/decrease in SLR affects the availability of money for credit with banks.
Under Liquidity Adjustment Facility (LAF) the banks purchase money from RBI on repurchase agreements.
Under SF, the scheduled commercial banks can borrow additional amount of overnight money from the Reserve Bank by dipping into their Statutory Liquidity Ratio (SLR) portfolio up to a limit at a penal rate of interest. This provides a safety valve against unanticipated liquidity shocks to the banking system
It is the rate at which the Reserve Bank is ready to buy or rediscount bills of exchange or other commercial papers.
Under this method, the central influence the credit growth in country through following techniques:
The central persuades the commercial banks to regulate the credit growth through oral and verbal communication.
There are many reasons for monetary policy not able to achieve its intended objectives. Some of the reasons are:
It is the process by which monetary policy interventions get transmitted to achieve the ultimate objectives like inflation or economic growth.
The Monetary Policy Committee (MPC) has been constituted by central government in September 2016 for maintaining price stability, while keeping in mind the objective of growth
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