Monetary policy

What is monetary policy?

It is concerned with the changes in the supply of money and
credit. It is the policy measure taken by the government to
influence the availability, cost and use of money and credit
with the help of monetary techniques to achieve specific
objectives.
It aims in influencing the economic activity through credit
and rate of interest.
Meaning and definition :

R.P. 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.

According to A. J. Shapiro, “Monetary Policy is the exercise of

the central bank’s control over the money supply as an
instrument for achieving the objectives of economic policy.”

In the words of D.C. 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.”
What are the Objectives?

1.Reasonable price stability: The primary objective of

monetary policy is to maintain price stability while keeping in
mind the objective of growth. Price stability is a necessary
precondition for sustainable growth.
To maintain price stability, inflation needs to be
controlled. The government of India sets an inflation target
for every five years. RBI has an important role in the
consultation process regarding inflation targeting. The current
inflation-targeting framework in India is flexible in nature.
Objectives of monetary policy:

2. Faster economic growth: Monetary policy can help in

faster economic growth by making credits easily available to
the agriculture and industrial sectors. These sectors require
short-term credits and long-term credits for capital needs
both working and fixed. These credits are provided by the
development and commercial banks. Easy availability of
credits at cheaper interest rates stimulates investment and
expanding the production capacity of the society which in
turn helps the economy grow faster.
Objectives of monetary policy:

3. Exchange rate stability: Exchange rate is the price of

home currency expressed in terms of any foreign currency.
If the exchange rate is very volatile leading to frequent ups
and downs in the exchange rate the international
community may loose confidence in our economy. Thus
suitable monetary measures should be adopted and
amended to maintain the stability of exchange rate.
As we know the main goal of monetary policy is to maintain
price stability ,it should be noted that this price stability is a
necessary precondition for sustainable economic growth.
How does this happen?
To maintain price stability, inflation needs to be controlled.
The government of India sets an inflation target for every five
years. RBI has an important role in the consultation process
regarding inflation targeting. The current inflation targeting
framework in India is flexible in nature.
What is inflation?
Inflation is the decline of purchasing power of a given
currency over time. In other words Inflation refers to the rise
in the prices of most goods and services of daily or common
use, such as food, clothing, housing etc. When inflation is
high, the cost of living gets higher as well, which ultimately
leads to a deceleration in economic growth.
What is Inflation Targeting:
It is a central banking policy that revolves around adjusting
monetary policy to achieve a specified annual rate of
inflation. The principle of inflation targeting is based on the
belief that long-term economic growth is best achieved by
maintaining price stability, and price stability is achieved by
controlling inflation.

Flexible inflation targeting: It is adopted when the central

bank is to some extent also concerned about other things, for
instance, the stability of interest rates, exchange rates, output
and employment.
1.What is Flexible Inflation Targeting Framework (FITF) ?
2. who fixes this target?

FITF is introduced in India after the amendment of RBI

Act,1934 in 2016. the government of India after consulting
the RBI fixes the inflation target every 5 years. While the
inflation target for the period between 5 August 2016 and 31
March 2021 has been determined to be 4% of the Consumer
Price Index (CPI), the Central Government has announced that
the upper tolerance limit for the same will be 6% and the
lower tolerance limit can be 2% for the same.
What is the purpose?
This frame work makes the RBI more accountable to the
government if it fails to meet the inflation targets. If the
percentage change in monthly Consumer Price Index
(headline CPI) year-on-year was outside or expected to be
outside a specific range of numbers (the “Target”) for a
certain duration, it gives RBI a justification to decrease or
increase short-term interest rates. Thus, price stability
became an overarching objective of monetary policy, moving
other factors to the background. Thus the monetary policy
frame work is controlled by the RBI.

If the inflation is more than the upper tolerance level then it is

to be known that the RBI failed to achieve the fixed targets.
Monetary policy instruments:

Various instruments of the monetary policy to influence the

market are:
1. Open market operations : These include both, outright
purchase and sale of government securities, for injection
and absorption of durable liquidity, respectively.

2. Bank rate : It is the rate at which the Reserve Bank is read
to buy or rediscount bills of exchange or other commercial
papers. This rate has been aligned to the MSF rate and,
therefore, changes automatically as and when the MSF rate
changes alongside policy repo rate changes.
3. Cash reserve ratio: The average daily balance that a bank
is required to maintain with the Reserve Bank as a share of
such percentage of its Net demand and time liabilities
(NDTL) that the Reserve Bank may notify from time to time
in the Gazette of India.

Several other techniques like influencing repo rate, reverse

repo rate, LSF,MSF etc are used to change the economy.
Monetary Policy Committee (MPC) :
In India, the policy interest rate required to achieve the
inflation target is decided by the Monetary Policy Committee
(MPC). MPC is a six-member committee constituted by the
Central Government . The MPC is required to meet at least
four times in a year. The quorum for the meeting of the MPC
is four members.
Summary:
Thus monetary policy uses the monetary instruments to
control inflation and maintain price stability with faster but
sustainable economic growth
THANK YOU