Monetary Policy Meaning
Monetary Policy: Under the terms of the RBI Act, this monetary policy was developed in 1934. This strategy, which can be either contractionary or expansionary, differs from fiscal policy, which controls the nation’s taxes and overall spending. Expansionary policy is used when there is a sudden increase in the overall amount of money. Contractionary policy is used when there is a slower rate of growth or decline in the money supply.
The central bank uses monetary policy, a procedure, to control the money supply in order to accomplish particular objectives including preventing inflation, preserving a fair exchange rate, generating employment, and fostering economic progress. Changing interest rates through open market operations, reserve requirements, or foreign exchange trading is part of monetary policy, whether it be directly or indirectly. Conducting monetary policy is the responsibility of the Reserve Bank of India (RBI). The Reserve Bank of India Act, 1934 specifically mandates this obligation.
With the advent of the Monetary Policy Framework (MPF), Monetary Policy Committee (MPC), and Monetary Policy (MPP) Process, there have recently been numerous changes made to how India’s monetary policy is established.
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Monetary Policy Committee
The policy interest rate needed to hit India’s inflation objective is now decided by the Monetary Policy Committee. The Central Government appoints the six members of the MPC (Section 45ZB of the amended RBI Act, 1934).
At least four meetings of the MPC must be held annually. Quorum for the MPC meeting is four participants. In the event of a tie, the Governor has a second or casting vote in addition to each MPC member’s one vote. Each MPC meeting ends with the publication of the resolution that was approved.
Every six months, the Reserve Bank is obligated to produce a report called the Monetary Policy Report that explains the causes of inflation and projects it for the following 6 to 18 months.
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Monetary Policy Objectives
High employment rates, a stable price level, and an improvement in economic conditions are all goals of monetary policy. There are six main goals of monetary policy, and they are listed here.
1. The Neutrality of Money
The primary proponents of the neutral money objective of monetary policy include several outstanding economists including Wick Steed and Robertson. The policy states that the government must aim to prevent money from being aligned with the economy of the nation. Economic turbulence can result from any shift in currency. They contend that altering any policy element will negatively impact the nation’s overall economic situation.
They further contend that rigorous adherence to the neutral monetary policy will minimise cyclical variations and prevent trade cycles, inflation, and deflation in the nation’s economy. The authorities in this place maintain a stable currency. The primary goal of this Monetary Policy objective is to maintain absolute stability in the money supply.
2. Exchange Stability
The conventional goal of monetary policy authority is exchange stability. One of the key goals of the Gold Standard for various nations was this. These movements served to automatically adjust any imbalances or changes to the amount of money. Unpredictability in the conversation rates will result in gold withdrawals or inflows, upsetting the undesirable payment balance.
As a result, stable currency rates are crucial for international trade. Therefore, the main goal of monetary policy is to stabilize and manage the external changes that are occurring in a nation. Avoiding factors that could lead to exchange rate instability is crucial.
- It may have a sharp volatility, which can increase market speculation.
- More volatility can result in significant losses, undermine domestic confidence, and create difficulties for international investors. This will have a negative influence on capital outflow, which is essential for capital formation and growth.
- More exchange rate fluctuations may also result in higher prices and higher levels of prices.
3. Price Stability
One of the main goals of monetary policy, it has received significant attention in the twenty-first century. The most reliable and significant goal of monetary policy is price stability.
Prices that remain steady boost public trust and eliminate cyclical volatility. Thus, it promotes economic equality and helps people appreciate the importance of business activity. As a result, the community experiences an overall wave of welfare and wealth that is beneficial to everyone.
Additionally, price stability promotes the improvement of the nation’s economic situation. Additionally, the growth in good output benefits both the nation and its citizens. Additionally, it raises imports while lowering exports. Following the introduction of the monetary policy, certain slight price increases also aid the successful operation of the nation’s economy.
4. Full Employment
People who were working were fired as a result of the unexpected rise in unemployment during the Great Depression, which led to widespread unemployment throughout society. It is acknowledged to be both economically wasteful and socially hazardous. As a result, it was also stated as the primary goal of monetary policy. Currently, it is also referred to as full employment, which could have a direct impact on the stability of the exchange rate and pricing. If both of these things operate together, everything will run more smoothly.
According to the economist, having a balance between saving and investment at the full employment level is the essential factor in achieving full employment. According to classical economists, full employment is a typical aspect of the economy, but in the current environment, it cannot be fully utilized; as a result, full employment is necessary for better improvement of the nation’s economic status.
They also consider those who worked for a period of time before losing their position to be employed. Following the completion of the goal of full employment, monetary policy must work toward price balancing. Some of the ways the policy can be applied are listed below:
- Given that disguised unemployment is on the rise in countries like India, monetary policy is more appropriate for nations like ours.
- The policy can address the genuine unemployment issue, which will fuel the nation’s brisk economic expansion.
- It is one of the most practical tools for promoting the community’s economic and social welfare.
5. Economic Growth
In recent years, economic development has gained significant attention from politicians and economists all across the world. Utilizing human, natural, and other resources is also necessary if we want to raise the per capita income of the nation. The majority of the time, a nation’s economy is determined by its per capita income. Another important goal of monetary policy is to enhance per capita income, which is necessary if we wish to boost the nation’s economy.
6. Stability in the Balance of Payments
Another goal of monetary policy is the balance of payments. It was first made available after the war. This monetary policy objective’s primary goal stems from the problem with global trade’s lack of international liquidity. It was believed that the increase in the payment balance deficit was decreased. Many less developed nations reduce their imports, which negatively impacts the economy and development of the nation. Consequently, this goal brings about a balance in the payments.
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Monetary Policy Instruments
1. Open Market Operations
These are transactions of financial instruments like bank bonds or government securities. In order to limit the flow of credit, the Reserve Bank of India must sell government securities, and in order to promote the flow of credit, they must also purchase government securities.
2. Cash Reserve Ratio
One of the most often employed instruments of monetary policy, it is also known as CRR. The Reserve Bank of India must retain a set portion of the back deposits with the banks as a balance or reserve. In 1990, the CRR was 15%; by 2002, it had dropped to 5%. Additionally, the CRR is 4% at the moment.
3. Statutory Liquidity Ratio (SLR)
Every financial institution is required to keep a specific amount of liquid assets on hand at all times. The Statutory Liquidity Ratio refers to this. In the same way as precious metals and bonds such as silver, gold, and diamonds are held in non-cash forms, so are these assets. In December 2019, the SLR was 18.25%.
4. Bank Rate Policy
The discount rate is one of its other names. It is the interest that the Reserve Bank of India levies on loans and other financial assistance given to banks. Credit volume will decrease and there will be less money available if the bank rate rises. The bank rate was 5.40% on December 31 and is still in effect today.
5. Credit Ceiling
This particular monetary policy tool gives the Reserve Bank of India access to advance knowledge regarding bank lending up to a predetermined threshold. Consequently, this forces the banks to give a specific loan to the industries.
Role of Monetary Policy
In order to establish a statutory and institutionalized structure for a monetary policy committee to achieve price stability while keeping growth as a goal in mind, the Reserve Bank of India Act of 1934 was changed by the Finance Act of 2016. The committee is in charge of determining the benchmark policy rate (repo rate) required to maintain inflation within the designated target level.
The main objective of monetary policy is to balance the supply and demand of money. As the economy expands, so does the demand for money. The central government increases the money supply proportionately to the increase in demand to prevent inflation.
Monetary Policy Types
1. Expansionary Monetary Policy
In order to increase the amount of money in circulation in the economy, this policy lowers interest rates, encourages central banks to purchase government securities, and reduces bank reserve requirements. An expansionary stance lowers unemployment while enhancing trade and consumer spending. An expansionary monetary policy’s primary goal is to encourage economic growth, but it may also lead to increased inflation.
2. Contractionary Monetary Policy
A contractionary monetary policy aims to reduce the amount of money in the economy. Increased interest rates, the sale of government bonds, and increased bank reserve requirements can all be used to achieve this. When the government wants to control inflation, it employs a contractionary strategy.
Monetary Policy FAQs
Q) What are the 3 monetary policies?
Ans. The Fed has traditionally used three tools to conduct monetary policy: reserve requirements, the discount rate, and open market operations.
Q) What are the 4 monetary policies?
Ans. Central banks have four main monetary policy tools: the reserve requirement, open market operations, the discount rate, and interest on reserves. 1 Most central banks also have a lot more tools at their disposal.
Q) What is monetary policy example?
Ans. Monetary policy refers to the steps taken by a country’s central bank to control the money supply for economic stability. For example, policymakers manipulate money circulation for increasing employment, GDP, price stability by using tools such as interest rates, reserves, bonds, etc.
Q) What is monetary policy and why is it important?
Ans. Monetary policy influences interest rates in the economy – like interest rates for housing loans, business loans and interest rates on savings accounts. Changes in interest rates influence people’s decisions to invest or consume, which ultimately affects economic growth, employment and inflation.
Q) What are the 2 types of monetary policy?
Ans. There are two main kinds of monetary policy: contractionary and expansionary.