Monetary Policy India

It is concerned with the changing the supply of money stock and rate of interest for the purpose of stabilizing the economy at full employment or potential output level by influencing the level of aggregate demand. At times of recession monetary policy involves the adoption of some monetary tools which tends to increase the money supply and lower interest rate so as to stimulate aggregate demand in the economy. At the time of inflation monetary policy seeks to contract aggregate spending by tightening the money supply or raising the rate of return.

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To ensure the economic stability at full employment or potential level of output.

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To achieve price stability by controlling inflation and deflation.

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To promote and encourage economic growth in the economy.

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Bank rate policy

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Open market operations

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Changing cash reserve ratio

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Undertaking selective credit controls

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Bank rate is the minimum rate at which the central bank of a country provides loan to the commercial bank of the country.

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Bank rate is also called discount rate because bank provide finance to the commercial bank by rediscounting the bills of exchange.

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When general bank raises the bank rate, the commercial bank raises their lending rates, it results in less borrowings and reduces money supply in the economy.

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Well organized money market should exist in the economy. It is not present in India

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It is use full during the times of inflation but it does not full fill its purpose during the time of recession or depression.

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It means the purchase and sale of securities by central bank of the country.

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It is useful for the developed countries.

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The sale of security by the central bank leads to contraction of credit and purchase there of to credit expansion.

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When the central bank purchases the securities the cash reserve of member bank will be increased and vise versa.

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The bank will expand and contract credit according to prevailing economic and political circumstances and not merely with reference to their cash reserves.

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When the commercial bank cash balance increase the demand for loan and advance should increase. This may not happen due to economic and political uncertainty.

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The circulation of bank credit should have a constant velocity.

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The bank have to keep certain amount of bank money with them selves as reserves against deposits.

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The increase in the cash rate leads to the contraction of credit only when the banks excess reserves.

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The decrease in the cash rate leads to the expansion of credit and banks tends to make more available to borrowers.

Problem: Measures:

Recession and unemployment (1) Central bank buys securities through open market operation (2) It reduces cash reserves ratio (3) It lowers the bank rate

  Money supply increases   Investment increases   Aggregate demand increases   investment

Aggregate output increases by a multiple of the increase in

Problem: Measures:

Inflation (1) Central bank sells securities through open market operation (2) It raises cash reserve ratio and statutory liquidity (3) It raises bank rate (4) It raises maximum margin against holding of stocks of goods Money supply decreases Interest rate raises

  Investment expenditure declines   Aggregate demand declines   Price level falls  

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Variable time lags concerning the effect of money supply on the national income.

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Treating Interest rate as the target of monetary policy for influencing investment demand for stabilizing the economy.

 Monetary

policy and savings.  Monetary policy and investment. › Cost of credit.. › Monetary policy and public investment. › Monetary policy and private investment.  Allocation

of investment funds.

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In recent years starting from the mid-nineties promoting economic growth is being given greater emphasis in monetary policy of RBI.

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Three sub-periods:

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Monetary policy of controlled examination(1951-1972).

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Monetary policy in the pre-reforms period(1972-1991) .

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Monetary policy in the post-reforms period(1991-2000).

Reserve bank’s responsibility in the circumstances is mainly to moderate the expansion of credit and money supply in such a way as to ensure the legitimate requirements of industry and trade and curb the use of credit for unproductive and speculative purposes.  To ensure controlled expansion, RBI used the instruments: Changes in bank rate Changes in cash reserve ratio Selective credit control

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Price situation worsened during the years of 19721974. to contain inflationary pressures RBI further tightened its monetary policy.

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It is similar to tight monetary policy.

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Liberal monetary policy adopted for encouraging private sector since 1996.  Two instrument for monetary management BY RBI since 1996: Reactivation of bank rate. Repo rate system .

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It is introduced through which RBI can add to liquidity in the banking system. Through repo system RBI buys securities from the bank and there by provide funds to them.

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Repo refers to agreement for a transaction between RBI and banks through which RBI supplies funds immediately against government securities and simultaneously agree to repurchase the same or similar securities after a specified time which may be one day to 14 days.

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It is the another instrument of monetary policy from June 2000 to adjust on a daily basis liquidity in the banking system.

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Through LAF, RBI regulates short-term interest rates while its bank rate policy serves as a signaling device for its interest rate policy in the intermediate period.

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The provision of appropriate liquidity to meet credit growth and support investment and export demand in the economy while placing equal emphasis on price stability.

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Consistent with the above pursuit of an interest rate environment which is conducive to price stability but at the same time it will maintain the momentum of growth.

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Consideration of measures in a calibrated manner in response to the evolving circumstances with a view to stabilizing inflationary pressures. These three points is used to meet the requirement of credit for economic growth and also used to check the inflationary expectation and inflationary situation that may arise.

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