Monetary Policy

MONETARY POLICY
MONETARY POLICY
Definition:
Monetary Policy refers to the credit control measures
adopted by the central bank of a country.
Monetary policy “as policy employing central bank’s
control of the supply of money as an instrument for
achieving achieves of general economic policy.”
Objectives of Monetary Policy
The following are the principal objectives of monetary policy:
• Full Employment
• Price Stability
• Economic Growth
• Balance of Payments
• Exchange Rate Stability
• Neutrality of Money
• Equal Income Distribution
Full Employment
Full Employment has been ranked among the foremost
objectives of monetary policy.
It is an important goal not only because unemployment leads
to wastage of potential output, but also because of the loss of
social standing and self-respect.
Price Stability
• One of the policy objectives of monetary policy is to stabilize
the price level.
• Economics favour this policy because fluctuations in price
bring uncertainty and instability to the economy.
Economic Growth
One of the most important objectives of monetary policy in in
recent years has been the rapid economic growth of an
economy.
Economic growth is defined as “the process where by the real
per capita income of a country increases over a long period of
time.”
Balance of Payments
Another objectives of monetary policy since the 1950s has
been to maintain equilibrium in the balance of payments.
Exchange Rate Stability
• Exchange rate is the price of a 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
might lose confidence in our economy.
• The monetary policy aims at maintaining the relative stability
in the exchange rate.
Neutrality of Money
Economist such as Wicksted, Robertson has always considered
money as a passive factor.
According to them, money should play only a role of medium of
exchange and not more than that.
Therefore, the monetary policy should regulate the supply of
money.
Equal Income Distribution
Many economists used to justify the role
of the fiscal policy is maintaining economic equality. However
in recent years economists have given the opinion that the
monetary policy can help and play a supplementary role in
attaining an economic equality.
Types of Monetary Policy
Monetary policy design changes as per the
goals set for the monetary policy and the emerging
economic scenario. The monetary policy is
characterised as expansionary policy, contractionary
policy, counter cyclical policy, rule based policy or
discretionary policy.
• Expansionary Monetary Policy

• Contractionary Monetary Policy
• Countercyclical Monetary Policy
• Rule Based Monetary Policy
• Discretionary Monetary Policy
Expansionary Monetary Policy
Expansionary or easy monetary policy aims at encouraging
spending on goods and services by expanding the supply of
credit and money by lowering the policy rates (bank rate or
repo rate), lowering the reserve requirements and purchasing
the government securities from the market.
Contractionary Monetary Policy

• Contractionary or tight monetary policy aims at preventing
inflation by contracting the money supply.
• Contraction in money supply is achieved by increasing
the policy rates, increasing the reserve requirements and
purchasing the government securities from the market.
Countercyclical Monetary Policy
Countercyclical policy aims at moderating the cyclical
fluctuations in the economy and stabilizing the economy
around its trend path by following countercyclical measures.
Rule Based Monetary Policy

• Under rule based policy money supply and related variables
are controlled by predetermined rules, norms and standards.
• The central bank authorities cannot use their discretion to
change the values of these variables.
Discretionary Monetary Policy
Discretionary Monetary Policy allows the central bank greater
autonomy in the conduct of monetary policy.
Under such a policy rather than getting constrained by the
pre-set rule, the central banks, after assessing the emerging
economic scenario and using its own judgment, can change
the values of money supply and the related variables.
Instruments of Monetary Policy
Credit control is an important tool used by Reserve Bank of India,
a major weapon of the monetary policy used to control the
demand and supply of money in the economy.
Quantitative Qualitative
• Rationing of credit
• Bank rate • Margin requirement
• Open market operation • Moral Suasion
• Cash Reserve Ratio (CRR) • Regulation of consumer
• Repo rate rate & Reverse Repo Rate Credit
• Statutory Liquidity Ratio (SLR) • Direct Action
Quantitative Instruments
• Bank Rate: The bank rate, also known as the Discount Rate, is
the oldest instrument of monetary policy. Bank rate is the
standard rate at which the bank is prepared to buy or
rediscount bills of exchange or other eligible commercial paper.
• Open Market Operations: open market operations are the

means of implementing monetary policy by which a central
bank controls its national money supply by buying and selling
government securities or other financial instrument.
• Cash Reserve Ratio (CRR): CRR is the percentage of a bank's

total deposits that it needs to maintain as liquid cash. This is an
RBI requirement, and the cash reserve is kept with the RBI. A
bank does not earn interest on this liquid cash maintained with
the RBI and neither can it use this for investing and lending
purposes.
• Repo Rate and Reserve Repo Rate: whenever the banks have
any shortage of funds they can borrow it from RBI. Repo rate is
the rate at which banks borrow rupees from RBI. Reverse repo
rate is the rate at which RBI borrow rupees from banks.
• Statutory Liquidity Ratio (SLR): Every bank should have a

portion of its Net Demand and Time Liabilities (NDTL) in cash,
gold, or other liquid securities. The Statutory Liquidity
Ratio (SLR) is the proportion of these liquid securities that a
bank must maintain. The Reserve Bank of India (RBI) can raise
this percentage by up to 40%.
Qualitative Instruments
• Rationing of credit: Credit rationing is a method of controlling
and regulating the purpose for which credit is granted by
commercial bank. It aims to limit the total amount of loans and
advances granted by commercial banks.
• Margin Requirements: Margin is the difference b/w the market

value of a security and its maximum loan value. Marginal
requirement of loan can be increased or decreased to control
the flow of chart.
• Regulation of Consumer Credit: If there is excess demand for
certain consumer durable leading to their high prices,
central bank can reduce consumer credit by increasing down
payment, and reducing the number of instalments of repayment
of such credit.
• Moral Suasion: Moral Suasion means persuasion and request. To

arrest inflationary situation central bank persuades and request
the commercial banks to refrain from giving loans for
speculative and non-essential purposes.
• Direct Action: Under the banking Regulation the Central Bank

has the authority to take strict action against any of the
commercial bank that refuses to obey the directions given by
Reserve Bank of India.
Significance of Monetary Policy
• Control Inflation or Deflation

• Availability of the Supply of money and Credit
• Integrated Interest Rate Structure
• Effective Central Banking
• Long-Term Loans for Industrial Development
• Creation of Financial Institutions
• Control Inflation or Deflation: Monetary policy is the policy used
by the government of a country to control inflation or deflation in
an economy, and this policies been implemented by the central
bank through the ministry of finance.
• Availability of the Supply of money and Credit : Monetary policy
is concerned with the charges in the supply of the money and
credit. It refers to the policy measures under taken by the
government or central bank to influence the availability, cost and
use of money and credit with the help of monetary techniques to
achieve specific objectives.
• Integrated Interest Rate Structure: In an underdeveloped
economy, there is absence of an integrated interest rate structure.
There is wide disparity of interest rates prevailing in the different
sectors of the economy and these rates do not respond to the
changes in the bank rate, thus making the monetary policy
ineffective.
• Effective Central Banking: To meet the developmental needs the
central bank of an underdeveloped country must function
effectively to control and regulate the volume of credit through
various monetary instruments, like bank rate, open market
operations, cash-reserve ratio etc.
• Long-Term Loans for Industrial Development: Monetary policy

can promote industrial development in the underdevelopment
countries by promoting facilities of medium-term and long-term
loan to the manufacturing units.
• Creation of Financial Institutions: The Monetary policy in a

developing economy must aim to improve its currency and
credit system. More banks and financial institutions should be
set up, particularly in both areas which lack these facilities.

Monetary Policy

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MONETARY POLICY

The following are the principal objectives of monetary policy:

• Expansionary Monetary Policy

Contractionary Monetary Policy

Rule Based Monetary Policy

• Open Market Operations: open market operations are the

• Cash Reserve Ratio (CRR): CRR is the percentage of a bank's

• Statutory Liquidity Ratio (SLR): Every bank should have a

• Margin Requirements: Margin is the difference b/w the market

• Moral Suasion: Moral Suasion means persuasion and request. To

• Direct Action: Under the banking Regulation the Central Bank

• Control Inflation or Deflation

• Long-Term Loans for Industrial Development: Monetary policy

• Creation of Financial Institutions: The Monetary policy in a

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