Monetary Policy

Introduction

• Monetary policy is the Central Bank’s policy for managing the proper amount of money supply and demand in the economy. The primary purpose of monetary policy is to maintain price stability while seeking growth. 
• The Reserve Bank of India (RBI) has the authority to issue monetary policy at any time, based on the state of the economy. RBI uses a variety of measures to attain the desired level of credit and monetary policy.

Objectives of Monetary Policy

To promote and encourage economic growth

• The economic growth is determined by the “Gross Domestic Product” only and it clearly indicates the performance of the economy. Monetary policy plays a crucial role in promoting and encouraging countries’ GDP through influencing the money supply in the market.
• If the central bank (Reserve Bank of India) increases the supply of money in the market, Bank & Financial institutions will have more money to lend with leveraged interest rates which attracts the borrowers to borrow money. Thus, this will increase economic activities such as investment, production, consumption etc, leading to economic growth.  

To control Inflation

• Inflation is one of the  major macroeconomic parameters and it is the mandate of the central bank to control inflation at a  certain level in order to achieve macroeconomic stability. 
• Inflation has a series of positive and negative impacts on the economy. The central bank (RBI) uses contractionary monetary policy measures to control inflation. 

To achieve Price stability

• Price Stability totally depends upon inflation or deflation.
• If inflation remains low or stable, the prices of goods and services will remain stable and if inflation is high or if there is any deflationary pressure, prices will become unstable. 
• To achieve price stability, the central bank or the Reserve Bank of India has set a target rate of inflation at 4 % which can vary at a tolerable rate of +/- 2 %. 

To generate employment       

• It is the central bank’s expansionary monetary policy framework which is traditionally used to combat unemployment in a recessionary period by lowering the interest rates.
• If the central bank maintains adequate money supply in the market and interest rates are also kept low then individuals, business houses or production houses will borrow more money from the banks or the financial institutions to invest in business or setting up of production houses which require association of large workforce in production activities. Thus this will lead to employment generation.

Types of Monetary Policy

• Expansionary monetary policy increases the total money supply in the economy which creates more economic activities and results in a sharp rise in GDP, which accelerates the growth of the economy.
• Contractionary monetary policy decreases the total money supply in the market when the market is under inflationary pressure.

Tools of Monetary Policy

1. Quantitative Instrument: Quantitative instrument deals with the quantity/ volume of the money supply. These instruments regulate or control the total volume of bank credit. 

• Cash reserve ratio (CRR)  
• Statutory Liquidity Ratio (SLR) 
• Bank Rate 
• Repo Rate 
• Reverse Repo Rate 
• Marginal Standing Facility (MSF) 
• Open Market Operation

2. Qualitative Instrument: Unlike quantitative tools which have a direct effect on the entire economy’s money supply, qualitative tools are selective tools that have an effect in the money supply of a specific sector of the economy. 

• Margin Requirement 
• Moral Suasion 
• Direct Action 
• Rationing of credit