The Reserve Bank of India uses various monetary policy instruments to achieve its objectives of price stability and economic growth. These include varying reserve ratios like the cash reserve ratio, using open market operations to purchase and sell government securities, and adjusting policy rates like the discount rate. The ultimate goals of monetary policy are to influence total spending, inflation, and other macroeconomic indicators through acting on monetary aggregates and interest rates. In recent decades, the RBI's monetary policy has focused on stabilizing inflation and liberalizing the economy.

1. Monetary Policy RBI and Monetary Policy in India

2. Monetary Magnitudes M 1 = Currency with public+ Demand deposits with banks+ Other Deposits with RBI M 2 = M 1 + Post Office Deposits M 3 = M 1 + Time Deposits with Banks M 4 = M 3 + Total Post Office Deposits

3. Growth of M 3 and Differential Contribution of Components Source: RBI-Macroeconomic and Monetary Developments: Third Quarter Review 2005-06

4. What is Monetary Policy? The term monetary policy refers to actions taken by central banks to affect monetary magnitudes or other financial conditions. Monetary Policy operates on monetary magnitudes or variables such as money supply, interest rates and availability of credit. Monetary Policy ultimately operates through its influence on expenditure flows in the economy. In other words affects liquidity and by affecting liquidity, and thus credit, it affects total demand in the economy.

5. Credit Policy Central Bank may directly affect the money supply to control its growth. Or it might act indirectly to affect cost and availability of credit in the economy. In modern times the bulk of money in developed economies consists of bank deposits rather than currencies and coins. So central banks today guide monetary developments with instruments that control over deposit creation and influence general financial conditions. Credit policy is concerned with changes in the supply of credit. Central Bank administers both the Credit and Monetary policy

6. Aims of Monetary policy MP is a part of general economic policy of the govt. Thus MP contributes to the achievement of the goals of economic policy. Objective of MP may be: Full employment Stable exchange rate Healthy BoP Economic growth Reasonable Price Stability Greater equality in distribution of income & wealth Financial stability

7. Price Stability: The Dominant Objective There is convergence of views in developed and developing economies, that price stability is the dominant objective of monetary policy. Price stability does not mean complete year-to-year price stability which is difficult to attain. Price stability refers to the long run average stability of prices. Price stability involves avoidance of both inflationary and deflationary pressures.

8. Price Stability contributes improvements in the standard of living of people. It promotes saving in the economy while discouraging unproductive investment. Stable prices enable exports to compete in international markets and contribute to the strengthening of BoP. Price stability leads to interest rate stability, and exchange rate stability (via export import stability). It contributes to the overall financial stability of the economy.

9. Operation of Monetary Policy Instruments Discount Rate (Bank Rate) 2.Reserve Ratios 3. Open Market Operations Operating Target Monetary Base Bank Credit Interest Rates Intermediate Target Monetary Aggregates(M3) Long term interest rates Ultimate Goals Total Spending Price Stability Etc.

10. Instruments of Monetary Policy Variations in Reserve Ratios Discount Rate (Bank Rate) (also called rediscount rate) Open Market Operations (OMOs) Other Instruments

11. Variations in Reserve Ratios Banks are required to maintain a certain percentage of their deposits in the form of reserves or balances with the RBI It is called Cash Reserve Ratio or CRR Since reserves are high-powered money or base money, by varying CRR, RBI can reduce or add to the bank’s required reserves and thus affect bank’s ability to lend.

12. Discount Rate (Bank Rate) Discount rate is the rate of interest charged by the central bank for providing funds or loans to the banking system. Funds are provided either through lending directly or rediscounting or buying commercial bills and treasury bills. Raising Bank Rate raises cost of borrowing by commercial banks, causing reduction in credit volume to the banks, and decline in money supply. Variation in Bank Rate has an effect on the domestic interest rate, especially the short term rates. Market regards the increase in Bank rate as the official signal for beginning of a tight money situation.

13. Open Market Operations (OMOs) OMOs involve buying (outright or temporary) and selling of govt securities by the central bank, from or to the public and banks. RBI when purchases securities, pays the amount of money by crediting the reserve deposit account of the seller’s bank, which in turn credits the seller’s deposit account in that bank.

14. Monetary policy also known as Money and Credit Policy: It concerns itself with the supply of money as also credit to economy Till 1998-99:It was announced twice in a year:Oct….for Oct..March….to coincide with busy season April…for April to Sept…to coincide with lean season of agri.With decline in agri. And rise in industrial credit since 1999-2000 in April RBI makes an annual policy statement and a review in Oct.

15. Since 1951 and till 1990s…. Two sets of objectives pursued… a)controlled expansion of money b)sectoral deployment of funds Done keeping in mind plan priorities Special attention… Core industries (coal, iron, steel and engg.) foodgrains (rice, wheat etc.) priority sectors ( agri., SSI) weaker sections of population

16. In general, the interaction between monetary and fiscal policy occurs To control inflationary or deflationary impact of fiscal policy For instance, a substantial multi-year rise in the deficit need not cause an increase in inflation was demonstrated in USA: Between 1979-85……budget deficit rose from 2.7% of GDP to 5.1% of GDP……national debt rose from 26% of GDP to 36% of GDP However, GDP price inflation fell from 8.2 % to 3.2% This due to a tough anti-inflationary monetary policy pursued by the Federal Reserve.

17. In India, for instance, In 90s… growth of economy remain primary aim control of inflation urgent concern (91….double digit….17%) 8th (92-97)…aimed at achieving trend rate of inflation 5% MP of 90s favored…process of stabilization and structural adjustment initiated in 91

18. Various measures used by RBI include: Rate of interest (or price of money) Quantity or supply of money Access to or demand for money One imp. Instrument is bank rate or discount rate.. Rate at which RBI lends to the banking system… Through it: short term interest long term rates level of economic activity international capital inflows Second imp. Instrument is sale or purchase of govt. securities (by sale of securities banks’ resources reduce and vice versa

19. Third imp. Instrument… Cash Reserve Ratio: Banks’ Cash Holding/Total Deposit Liabilities Fourth Imp. Instrument is Statutory Liquidity Ratio(SLR)… RBI imposes an obligation on banks to buy govt. Securties (of Low interest rates)(25% at present) To achieve the objective of sectoral deployment of credit.. Direct (Quantity)… Reserve ratios Quantitative controls on RBI lending to banks and commercial sector Quantitative credit controls Indirect Instruments… administrative setting of various interest rates: e.g. RBI lending commercial bank lending deposits

20. In 1960s .. Emphasis was on indirect measures with little variation in reserve ratios In1970s… Emphasis shifted to direct approaches and persisted since then Shift from indirect to direct measures was prevalent more due to rising deficit or inflation Monetary instrument in India, both direct and indirect, operate Through administrative controls or fiat The crisis like droughts, oil crisis in 1966,1969, 1973 were dealt with effectively by cutting down domestic credit

21. One of the main problem area in the monetary policy lie with the Exogenous element in reserve money. Reserve money comprise of: Increased RBI lending to govt. (relates to fiscal deficit) Increased RBI lending to commercial banks Growth of net foreign exchange of RBI RBI can control only b) by prescribing high SLR Monetary control has been reasonably successful in spite of rising Fiscal deficit because of aggressive use of the reserve ratios In a sense reserve ratios have not been genuinely monetary policy Instrument but rather acted as fiscal policy instrument