Lesson XII Monetary Policy
Reading Objective:
After reading this chapter the reader may be able to understand that the monetary policy is the policy of the monetary authority namely central bank of the country to achieve certain goals like controlling the inflation, deflation, obtaining full employment and economic development of the country. The objectives of the monetary policy may change from time to time. In recent past, the people of India were appreciating the Honorable finance minister Mr.P.Chidambaram, Dr.Y.V.Reddy the former Governor, Reserve Bank of India and the Dr.D.Subba Rao the present Governor, Reserve Bank of India for their deft handling of the economic condition of India from without being affected by the global financial meltdown. The Monetary authority of the country has certain tools in its hands and uses it depending upon its understanding of the economic conditions of the country.
Lesson Outline:
Monetary policy is an important economic tool which is used to attain many macroeconomic goals. Monetary policy regulates the supply of money and availability of credit in the economy. It deals with both the lending and borrowing rates of interest of commercial banks. It aims to maintain price stability, full employment and economic growth. Reserve Bank of India (RBI) is responsible for formulating and implementing monetary policy of India. It was announced twice a year (slack season and busy season) but now once in a year. It refers to the credit control measures adopted by the central bank of a country.
The efforts of monetary authorities to increase the benefits of existing monetary system and to reduce the disabilities in the process of economic development and growth can be called the monetary policy of the country.
Objectives Of Monetary Policy Of India:
Instruments: The major instruments used to achieve the above said objectives are
Bank rate: The rate of interest charged by the RBI against the commercial bank borrowings. If RBI increases the bank rate from 2% to 3% then the commercial banks rate of interests will go up from for example 7% to 10% which in turn reduce the public borrowings due to higher interests and minimize the money circulation in the country.
Reserve ratio: CRR (Cash Reserve Ratio), SLR (statutory Liquidity Ratio) the RBI insist on commercial banks to keep a certain percentage as reserve in their hands for ensuring liquidity and regulating credit. The RBI can increase the CRR from 3% to 15%. In case when the RBI increases CRR from 10% to 12% then the availability of money in the hands of banks will come down. Thus the credit creating capacity of the commercial banks will be reduced and money supply in the market also will be regulated.
Open market operation: RBI selling the government securities to the public. In that case instead of having money in the hands the public will receive certificates for a fixed time period and they will receive interest against the same. But the money circulation among the public will be reduced.
Margin requirements: Margin requirement for mortgaging against the loans will be increased to reduce to credit and it will be reduced to increase the credit flow.
Credit rationing: The loans and advances are provided only for production purpose and for essential activities to cut down the money in circulation.
Moral suasion: RBI controls the commercial banks for creating loans and advances by persuasion through issue of circular.
Direct actions: Sometimes RBI takes direct action against the credit created by the banks in contravention of the RBI guide line to overcome the inflationary situation.
Limitations Of Monetary Policy:
Monetary Policy And Economic Development:
Monetary policy refers to various decisions and measures of the monetary authorities, state and central bank, influencing money supply and credit situation in the monetary system as a whole with a view to full fill certain macro economic goals. It deals with the cost of credit and the availability of credit. Monetary policy is the attempt by the government or its agent, the central bank, to manipulate monetary variables such as the rate of interest or the money supply to achieve policy goals.
Review Questions:
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