Objectives, Tools and Types of Monetary Policies in India

Monetary policies are authorised, implemented and changed only with the permission of the central bank. They bring in banks as the medium to control and manage finances to ensure economic development. These policies are essential for management of inflation, and also for managing employment levels in the country.

There are various objectives set with the implementation of monetary policies. The central bank also disseminates the various tools for application of the monetary policies. Furthermore, there are specific types of monetary policies operated by the central bank. Understanding what monetary policies are is essential for knowing their objectives, tools and types.

Overview of monetary policies

Monetary policies are policies that are initiated by the central bank in a country to stabilise the economy. The prominent role of these policies is to maintain the supply of money that is used by the government, consumers and other enterprises. Monetary policies include the revision of interest rates and inflation rates, cash lending, bank reserve requirements and deposits in banks.

Monetary policies in India are framed by the Reserve Bank of India (RBI). It is the sole proprietor that controls the supply of money across the country and to the state banks. The RBI provides opportunities for investments, lending, and cash to banks. It is completely independent in the matter of framing monetary policies. No interventions can be made by the government in the workings of the RBI.

The monetary policies set in India aim to achieve various objectives. These objectives are a framework of how successful monetary policies can be. The next section elaborates the various objectives of monetary policies.

Objectives of monetary policies

Monetary policies are put in place to achieve three types of objectives – control inflation, counter unemployment, and maintain currency exchange rates.

• Inflation

Monetary policies are the deciding factors in how much value in terms of goods the currency of a country holds. Inflation is a situation where a certain quantity of a good is at a price that is overblown when compared to the price of the same quantity when the situation is normal. An example of inflation is seen during the Great Depression that took place between 1929 and 1939, when the price of bread was exponentially high. Since zero inflation is very tough to achieve, a low inflation level has to be maintained for the growth of the economy and monetary policies are established to achieve these levels.

• Unemployment

Unemployment is a factor that is related to the effect that funds in a country have over the living conditions of the country. Using monetary policies, situations can be created that are favourable to creating more job opportunities. For example, when an expansionary monetary policy is established, more funds are released into the market, which allows various businesses to expand. The expansion in businesses causes the generation of more jobs and subsequently also decreases the unemployment rate.

• Currency exchange rates

Central banks use their authority to regulate the currency exchange rates by establishing the necessary monetary policies to achieve this. For example, if the value of the domestic currency compared to a foreign currency has to be increased then the central bank will issue a monetary policy to increase the scarcity of the domestic currency.

Types of monetary policies

Monetary policies can be divided into two groups:

1. Expansionary monetary policy: This type of monetary policy aims at increasing the amount of money that is available in the market. Under such a policy, the central bank may take measures such as decreasing the discount rate, purchasing government securities, and so on.
2. Contractionary monetary policy: This type of monetary policy aims at decreasing the amount of money that is available in the market, and is usually implemented to decrease inflation in the market.

Tools of monetary policies

When making decisions relating to monetary policies, central banks have to take various actions using different economic tools, some of the most popular of which are:

• Adjusting the interest rate 

The interest that banks charge their customers when lending money can be influenced by the actions of the central bank. Commercial banks are charged a specific rate called the discount rate by the central bank when they offer short-term loans to their customers. By changing the discount rate, commercial banks are forced to change the interest rates they charge to their customers. Thus the amount of borrowing in the country changes, affecting the amount of funds in the country.

• Changing the reserve requirement

All commercial banks are required to maintain a certain reserve with the central bank. When the amount of money that banks are required to maintain with the central bank is changed, it can influence the total money that is available in the Indian market.

• Open market operations

The central bank can involve itself in the purchasing and selling of government-issued securities to affect the amount of money in the market. When the central bank sells government-issued securities, it causes more money to come out of the market and when it purchases these securities, it increases the amount of money in the market.

Conclusion

Monetary policies help control various situations involving the money that is available in a country’s market. They are usually implemented by the central bank of the country and mainly deal with the country’s inflation rate, unemployment level and currency exchange rate.