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Monetary Policy: Objectives, Meaning, Instruments, Monetary Policy in India UPSC Notes

By Balaji

Updated on: March 8th, 2023

Some of the key objectives of Monetary policy are price stability, neutral money, exchange stability, stability in the balance of payments, achieving full employment, etc. Monetary Policy is the practice of regulating the money supply in an economy by the Reserve bank of India (RBI). Its main use in the nation or states is to adjust the inflation and the interest rates to have rate stability and maintain the exchange rate with the other nations. There are various objectives of Monetary Policy which are explained in detail in this article.

The Reserve Bank of India has total control over the Monetary Policy in India in corporation with the central government to have a developmental agenda. It is an important topic that must be covered while preparing for the UPSC prelims and mains examinations as questions can be asked about the meaning, objectives, and instruments of Monetary policy.

Table of content

(more)
  • 1. What is Monetary Policy? (more)
  • 2. Monetary Policy in India (more)
  • 3. Objectives of Monetary Policy (more)
  • 4. Tools of Monetary Policy (more)
  • 5. Importance of Monetary Policy (more)
  • 6. Instruments of Monetary Policy (more)
  • 7. Role of Monetary Policy (more)
  • 8. Types of Monetary Policy (more)
  • 9. Limitations of Monetary Policy (more)
  • 10. Fiscal Policy vs Monetary Policy (more)
  • 11. Monetary Policy UPSC (more)

What is Monetary Policy?

Monetary Policy is a set of guidelines laid out by the Reserve Bank of India which governs the entire functioning of all the financial institutions of the country. The RBI monetary policy controls the interest rates of banks including other rates such as the SLR, CRR etc.

The Monetary Policy in India keeps a check on the liquidity and inflation in the economy. The RBI shifts the rates accordingly which leads to increased or decreased inflation in the economy. The policy helps keep the prices of goods and services stable and in check.

Monetary Policy in India

In order to promote economic growth, RBI uses Monetary Policy to control the overall money supply in the economy.

Monetary Policy UPSC Notes

  • This Monetary Policy was constructed under the RBI Act in 1934.
  • This policy is often considered a contractionary or an expansionary and is different from the fiscal policy, which manages the taxes and overall expenses of the country.
  • When the total money is increased more suddenly than normal, it is called expansionary policy.
  • When a slower increase or decrease in money occurs, it is called contractionary policy.

Objectives of Monetary Policy

Monetary Policy was designed in order to provide high employment, reasonable price stability, and an increase in the growth of economic conditions. There are 6 major objectives of Monetary Policy, which are mentioned below.

The Neutrality of Money:

Many great economists like Wicksteed and Robertson are the chief of the neutral money objective of Monetary Policy. According to the policy, authorities must target to have the nonalignment of money in the country’s economy. Any monetary change can cause economic fluctuations. According to them, changing any policy factor will adversely affect the country’s overall economic condition. They also believe that if the neutral monetary policy is strictly followed, cyclic fluctuations will be minimal; there will be no trade cycle, no inflation, or deflation in the country’s economy. Here, the money is kept stable by the authorities. The main aim of this objective of Monetary Policy is to keep the quantity of money perfectly stable.

Exchange Stability:

Exchange stability is the traditional objective of Monetary Policy authority. This was one of the main objectives of the Gold Standard for different countries. When there was a disturbance in the amount of money or a disbalance, it was automatically corrected by these movements. Uncertainty in the conversation rates will cause the outflows or inflows of gold, creating a disturbance in the undesired payment balance.

Therefore, stable exchange rates are essential to inter-country trade. Therefore, Monetary Policy is primarily concerned with controlling and stabilizing the external changes taking place in a country. It is important to avoid forces that will cause instability in the exchange rate.

  1. It can have a violent fluctuation which can encourage speculative activities in the market.
  2. More fluctuations can also make a tremendous loss and lower the confidence of the domestic people and cause problems for foreign capitalists, which will result in a bad impact on the capital outflow, which is responsible for capital formation and growth.
  3. More Fluctuations in exchange rates can also make the price greater, and the level of prices will also be increased.

Price Stability:

This is one of the major Monetary Policy objectives, and it has been highlighted during the present century. Price stability can be called the most trusted and important objective of Monetary Policy.

Stable prices increase common people’s confidence, and cyclical fluctuations are eliminated. Thus, it helps people understand the value of business activities and will give equal income and wealth distribution. Due to this, a general wave of welfare and prosperity arrives in the community and benefits everyone.

Price stability also encourages the growth of the economic condition of the country. And the good production also increases which is also benefited to the country as well as the people. It also decreases exports and increases imports. Some small increase in the prices after the implementation of the Monetary policy also helps the country’s economy to work well.

Full Employment:

During the period of the world depression, the unemployment problem increased suddenly, so the people who were employed were thrown out, which caused a lot of unemployment in society. It has been recognized as socially dangerous and economically wasteful. Thus, it was also listed as the main objective of Monetary Policy. Currently, it is also referred to as if we can achieve full employment; it could directly affect the price and the exchange stability. This will all work better if both these things work together.

The economist says that the main reason to achieve full employment is to have a balance between saving and investment at the full employment level. Classical economist says that full employment is a normal feature of the economy, but in the current situation, it cannot be completely applied; thus, we need to have full employment for better growth of the country’s economic situation.

According to them, the people who worked for some time and lost their job after some time are also called employed. After completing the aim of comprehensive employment, Monetary Policy must try to have price balancing. Below mentioned as some of the ways through which the policy can work upon:

  • Analyzing the current unemployment and disguised unemployment is growing in a country like India; thus, Monetary Policy is more suitable for the countries like ours.
  • The policy can solve the real unemployment problem, leading to the country’s rapid economic growth.
  • It is one of the most useful tools that can provide economic and social welfare to the community.

Economic Growth:

Economic growth has become a major topic of discussion among economists and statesmen around the world in recent years. We also need to use natural, human, and all other resources to increase the country’s per capita income. Most of the time, a country’s economy is decided as per the per capita income of the country. If we want to increase the country’s economy, the per capita should also be up to the mark, which is another significant objective of the Monetary policy.

Stability in the Balance of Payments:

The main aim of this Monetary Policy objective is because of the issue of international liquidity of world trade. It was felt that the increase in the deficit in the balance of the payment was reduced. Many less-developed countries curtail their imports, which badly affects the country’s economy and development. Thus, this objective creates a balance in the payments.

Tools of Monetary Policy

The tools of Monetary Policy can be broadly classified into two major categories of Qualitative tools and Quantitative tools. These tools are utilized in order to maintain the growth rate of the economy thereby controlling inflation.

  • Qualitative Tools of Monetary Policy: These tools are also referred to as ‘selective’ as they are not used as rigorously as the Quantitative tools. These are used for differentiating between the variety of uses of credit facilities. Examples are – Credit Rationing, Consumer Credit Regulation, etc.
  • Quantitative Tools of Monetary Policy: These types of tools come under the general category that is used more often by the RBI. They are used to limit the amount of money in the economy which is termed liquidity. Some examples are Bank Rate, Open Market Operations, Repo Rate, Reverse Repo Rate, SLR, CRR, etc.

Importance of Monetary Policy

Monetary Policy is an extremely important tool which is required to stabilize the economy. It is the duty of the Central Bank to frame the policy. The RBI is also responsible to make sure that the monetary policy in India is implemented to the core.

The importance of the Monetary Policy lies in its ability to directly influence the Indian economy. Its main target is the inflation rate along with ensuring the stability of the prices in the Indian market. Maintaining the growth rate of the economy is one of the primary objectives of the RBI Monetary Policy.

Instruments of Monetary Policy

The instruments of monetary policy introduced and regulated by RBI to control the money supply in the economy are as follows:

  • Open Market Operations: These are exchanges of the securities like government bonds or banks. The Reserve Bank of India need to sell government securities to have control over the flow of credit, and they also need to buy government securities to increase the credit flow.
  • Cash Reserve Ratio: It is also called CRR, which is one of the most commonly used instruments of monetary policy. A specific amount of the back deposit with the banks is needed to keep with the Reserve Bank of India in the form of a balance or reserve. The CRR was 15% in 1990, which was got down to 5 % in the year 2002. And currently, the CRR is 4 per cent.
  • Statutory Liquidity Ratio (SLR): All financial institutes need to maintain a certain level of liquid assets within themselves at any time of their total time. It is what is meant by the Statutory Liquidity Ratio. These are the assets kept in a non-cash form, just like silver, gold, diamonds, and other precious metals and bonds. The SLR stood at 18.25 per cent in December 2019.
  • Bank Rate Policy: It also has another name which is the discount rate. It is the interest that the Reserve Bank of India charges for providing loans and funds to the banks. If the bank rate increases, the credit volume will go down, and the available money will be less. On 31st December 2019, the bank rate was 5.40% and is continuing till today.
  • Credit Ceiling: This is the type of Monetary policy instrument which make the Reserve Bank of India prior information about the loans to the bank will be made available to a certain limit. Thus, this makes the banks have a certain loan to the sectors.

Role of Monetary Policy

The Finance Act of 2016 revised the Reserve Bank of India Act 1934 to provide a statutory and institutionalised framework for a monetary policy committee to ensure price stability while keeping growth as a goal in mind. The responsibility of setting the benchmark policy rate (repo rate) necessary to keep inflation within the designated target level falls to the committee. The key role of monetary policy is to adjust the relationship between the supply and demand for money. The demand for money continues to rise as the economy grows. To prevent inflation, the central government raises the money supply proportionately to the rise in demand.

Types of Monetary Policy

Monetary policies are viewed as either expansionary or contractionary depending on how much the economy is growing or stagnating. The types of monetary policy are explained below:

  • Expansionary Monetary Policy: This policy lowers interest rates, encourages central banks to buy government securities, and lowers bank reserve requirements to raise the amount of money in circulation in the economy. A policy of expansion reduces unemployment while boosting commerce and consumer expenditure. The main objective of an expansionary monetary policy is to promote economic growth, and it may, however, also result in higher inflation.
  • Contractionary Monetary Policy: Reducing the amount of money in the economy is the aim of a contractionary monetary policy. It can be accomplished by boosting interest rates, selling government bonds, and raising bank reserve requirements. When the government wishes to keep inflation levels under control, it uses a contractionary strategy.

Limitations of Monetary Policy

One of the major limitations of the Monetary Policy is that it is not able to concentrate on the non-monetary aspects of the economy. There are other factors as well that control the country’s economic growth apart from the monetary front. Some other limitations of the Monetary Policy in India are given below:

  • Limited contribution with respect to the economic growth of the country.
  • Less involvement in the controlling of commodity prices.
  • The Monetary Policy is not able to encourage a cashless economy & increase the deposit of the banks as the Indian people are more interested in cash transactions.
  • Another major limitation of the Monetary Policy in India is that the money market is not so much developed which plays a negative role in the functioning of the economy.

Fiscal Policy vs Monetary Policy

Fiscal Policy and Monetary Policy are two kinds of financial tools that are brought into use by the concerned financial organizations & the government. They both are crucial for the growth of the economy.

Fiscal Policy Monetary Policy
This tool is utilized by the Central government. It is used by the Central Bank- the Reserve Bank of India.
Controls the money being circulated in the revenue collected from taxes & the financial policies that are related to the spending & expenditure for the economy. Regulates the money supply & interest rates of the bank.
Dedicated towards the growth of the economy. Focused more towards stabilizing the economy.

Monetary Policy UPSC

Monetary Policy UPSC is an essential topic from the Indian Polity subject, and it is important for both UPSC Prelims and Mains exams. All aspirants must have knowledge and information about the details of the Monetary Policy according to the UPSC Syllabus and should know every small detail related to the latest updates on the RBI monetary policy 2022 for excellent preparation and results. Candidates can also go through UPSC previous year question papers to understand the types of questions asked in this section.

Monetary Policy UPSC Question

Question – Under which qualitative tool RBI fixes the maximum limit to loans and advances that can be made, above which the commercial banks cannot exceed?

  1. Rationing of credit
  2. Margin requirement
  3. Loan-Value ratio
  4. Moral Suasion

Answer: A) Rationing of credit.

Other Important UPSC Notes
Good Governance Social Empowerment
Public Distribution System Ayushman Bharat Scheme
Wetlands in India Special Economic Zone In India
National Commission for Women Zero Coupon Bond
Black Carbon Permanent Settlement

 

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