What does it mean to tighten monetary policy?

By Ritesh|Updated : September 2nd, 2022

The tightening monetary policy means that the central bank increases interest rates and reduces the money supply. When there is unbridled economic growth, the central bank tightens monetary policy. Contractionary monetary policy is also known as monetary tightening. Monetary policy tightening is done when inflation is rising rapidly. As part of this policy, banks' minimum reserve requirements are increased, and government securities are sold.

Tight Monetary Policy Meaning and Effects

  • Monetary policy is adopted by a country's monetary authority, which controls either the interest rate payable on a very short-term loan or the money supply.
  • Policy often targets inflation or the interest rate to ensure price stability and create confidence in the currency.
  • Monetary policy in India is conducted under the supervision of the Reserve Bank of India.

The main objective of monetary policy:

  • Simply put, the main goal of monetary policy is to maintain price stability while keeping in mind the purpose of growth, as price stability is a prerequisite for sustainable economic development.
  • In India, the RBI plays a vital role in controlling inflation through a consultative process on inflation targeting. The current inflation targeting framework in India is flexible.

The role of the Monetary Policy Committee

  • The Finance Act 2016 amended the Reserve Bank of India Act 1934 (RBI Act) to offer an institutionalized and statutory framework for the Monetary Policy Committee to maintain price stability along with the growth objective.
  • The Monetary Policy Committee sets the reference interest rate (repo rate) needed to keep inflation within the target level.
  • The Indian Government announced the "inflation target" in the Gazette of India on August 5, 2016, for the period commencing from the publication of the notification date and ending on 31 March 2021 as 4%.
  • The lower and upper tolerances of 2% and 6% were announced.

Summary:

What does it mean to tighten monetary policy?

When there is unbridled economic growth, the central bank tightens monetary policy. Monetary policy tightening is done when inflation is rising rapidly. When tightening monetary policy, the central bank increases interest rates and reduces the money supply.

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