5. Objectives of monetary policy in India. Tools to achieve it.
Introduction
Monetary policy
Monetary policy is the macroeconomic policy involving involves management of money supply
and interest rate and is the demand side economic policy used by the government of a country to
achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
Monetary policy deals with supply of money in the economy by its control over interest rates to
maintain price stability. It can also be termed as policy of a central bank of a country with
respect to supply of availability and cost of credit. It is mainly designed to maintain the price
stability in the economy.
Central banks of different countries
India- Reserve Bank of India
US- Federal Reserve Bank
England- Bank of England
Types of Monetary Policies
1. Expansionary Monetary Policy known as Easy Money Policy or Loose Money
Policy as central banks seeks to increase the money supply by lowering the interest rates.
2. Contractionary Monetary Policy known as tight money policy as central banks seeks to
reduce the money supply by restricting credit by increasing interest rates.
3. Unconventional Monetary Policy is pursued by central banks when their traditional
instruments of monetary policy cease to achieve their goals.
Flexible
Inflation
Targeting
Framework
Monetary Monetary
Policy Policy
Framework Committee
Monetary
Policy
Monetary Monetary
Policy Policy
Process Instruments
Objectives of Monetary policy
1. Growth with Stability
2. Regulation, Supervision, and also Development of Financial Stability
3. Promoting Priority Sector
4. Generation of Employment
5. External Stability
6. Encouraging Savings as well as Investments
7. Redistribution of Income and Wealth
8. Regulation of NBFIs
Price stability: RBI will control inflation and promote growth of an economy by providing
sufficient credit for the increasing needs of the different sectors of the economy.
Regulation, Supervision, and Development of Financial Stability: Internal and External
shocks can threaten the financial stability of a country and destabilize its financial system.
Therefore, the RBI gives a lot of importance to maintaining confidence in the country’s
financial system through adequate regulation and controls.
Exchange rate stability: Too much of price volatility is danger to the economy as it impacts
Foreign Institutional Investment and Foreign Direct Investment. Exchange rate stability is
very much important for countries like Singapore, but for India Multi objective approach is
followed
Promoting Priority Sector: In India, the priority sector includes agriculture, export, small-
scale enterprises, and the weaker section of the population. RBI consistently ensures that the
banking system provides timely and adequate credit to these sections at affordable costs.
External Stability: As the imports and exports are increasing, India’s linkages with the global
economy are getting stronger. Traditionally, the RBI determined the exchange rate and also
controlled the foreign exchange market. Through this mechanism, the RBI influences the
exchange rate by buying or selling foreign currencies in the open market.
Subsidiary objectives of Monetary policy in India
1. Promoting growth of money market and capital market
2. Regulation of commercial banks and financial institutions
3. Channelize flow of credit to priority sectors
4. Publications of reports and records
Tools used for achieving monetary policy in India
Open Market Operations (OMO)
It is the process of buying and selling of government securities, bond or Treasury Bills
(T-Bills) to regulate the money supply in economy. If government wants to reduce money
supply, it issues these bonds. The money is consumed to buy these bonds thus it reduced
the monetary base of the economy. Similarly to increase the money supply, the
government sells these bonds thereby increasing the monetary base of the economy.
Cash Reserve Ration (CRR)
It refers to the cash which banks have to maintain with the Reserve Bank of India as
percentage of Net Demand and Time Liabilities (NDTL). An increase in CRR makes it
mandatory for banks to hold large portion of their deposits with the RBI. Therefore it
reduces their deposit available for credit and they lend less which affect their profitability
and also reduces the money supply in economy.
Statutory Liquidity Ratio (SLR)
The banks in India are required to maintain liquid assets in the form of gold, cash and
approved securities. The increase/decrease in SLR affects the availability of money for
credit with banks.
MSF - Marginal Standing facility - It is a special window for banks to borrow from
RBI against approved government securities in an emergency situation like an acute cash
shortage. MSF rate is higher then Repo rate. Current MSF Rate: 4.25%
Liquidity Adjustment Facility (LAF)
Repo Rate: It is the interest rate at which the Reserve Bank provides overnight liquidity
to banks against the collateral of government and other approved securities under the
liquidity adjustment facility (LAF)
Reverse Repo Rate: The (fixed) interest rate at which the Reserve Bank absorbs
liquidity, on an overnight basis, from banks against the collateral of eligible government
securities under the LAF
Bank Rate :It is the rate at which the Reserve Bank is ready to buy or rediscount bills of
exchange or other commercial papers.
SLR Rate 18 %
CRR 3%
MSF 4.25%
Repo rate 4%
Reverse repo rate 3.35%
Base rate 8.15%-
9.40%
MSF 4.25%
