Monetary Policy: Framework, Goals, Expansionary & Contractionary, MONETARY POLICY COMMITTEE, Flexible Inflation Targeting,

Monetary policy: 

Monetary policy consists of the actions of a central bank, or any regulatory committee (Monetary Policy Committee) that determine the size and rate of growth of the money supply in the economy . Under the Reserve Bank of India, Act,1934 (RBI Act,1934) (as amended in 2016), RBI is entrusted with the responsibility of conducting monetary policy in India with the primary objective of maintaining price stability while keeping in mind the objective of growth.

 Monetary Policy Framework :

The monetary policy framework in India has evolved over the past few decades in response to macroeconomic conditions over the years. The preamble of the Reserve Bank of India (RBI) Act, 1934 , amended in 2016, redefines  the mandate of the RBI as follows :“to regulate the issue of Bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage; to have a modern monetary policy framework to meet the challenge of an increasingly complex economy; to maintain price stability while keeping in mind the objective of growth.

 

The Goals of Monetary Policy are :

• Price stability 
• Financial Stability
• Exchange rate management 
• Economic Growth 

Based upon the recommendations of Urjit Patel Committee, In Feb 2015, Monetary policy framework agreement was signed between the Reserve Bank of India (RBI) and GOI. This was followed up with the amendment to the RBI Act, 1934 in May 2016 to provide a statutory basis for the implementation of the Flexible Inflation Targeting (FIT) framework.

Flexible Inflation Targeting:

• The framework provided for the implementation of the flexible inflation targeting framework and then onwards primary objective of RBI is price stability while keeping growth in mind.
• The amended RBI Act also provides for the inflation target to be set by the Government of India, in consultation with the Reserve Bank, once in every five years. Accordingly, the Central Government has set 4 per cent Consumer Price Index (CPI) inflation as the target for the period from August 5, 2016 to March 31, 2021 with the upper tolerance limit of 6 per cent and the lower tolerance limit of 2 per cent.

RECENT UPDATE  :

Accordingly, in a notification on March 31, 2021, the Central Government, in consultation with the RBI, retained the inflation target for the 5-year period April 1, 2021 to March 31, 2026.

 

Trilemma of RBI :

Along with growth and inflation, Monetary policy also maintains exchange rate. Many a times ,maintaining a balance between Growth , inflation and Exchange rate is said to be the Trilemma of RBI  while balance between growth and inflation is dilemma of RBI.

 

MONETARY POLICY COMMITTEE:

 

The Monetary Policy Process: Section 45ZB of the amended RBI Act, 1934 provides for an empowered six-member monetary policy committee (MPC) to be constituted by the Central Government . Monetary policy is formulated by Monetary Policy committee (MPC).The committee comprises of 6 members including RBI Governor. RBI governor is the chairperson of MPC.MPC comprises of members from RBI and GOI and the decision is based on consensus .REPO rate is exclusively decided by MPC otherwise all other rates except REPO rate are decided by RBI governor.

The proceedings of MPC are confidential and the quorum for a meeting shall be four Members, at least one of whom shall be the Governor and in his absence, the Deputy Governor who is the Member of the MPC. The MPC takes decisions based on majority vote . In case of a tie, the RBI governor will have the second or casting vote. The decision of the Committee would be binding on the RBI. The government may, if it considers necessary, convey its views, in writing, to the MPC from time to time.

RBI is mandated to furnish necessary information to the MPC to facilitate their decision making and if any Member of the MPC, at any time, requests the RBI for additional information, including any data, models or analysis, the same have to be provided, not just to that member but to all members.

 

 

Classification of Monetary Policy:

Monetary policy can be classified as follows:

Classification based upon normal and abnormal economic cycle. Monetary Policy can be classified as :

●        unconventional monetary policy

●        Conventional Monetary policy

Based upon liquidity position in the market, Monetary policy can be classified as :

●        Expansionary

●        Contractionary

 

Conventional vs Un-Conventional Monetary Policy :

Conventional monetary policy:

Monetary policy adopted by central bank to attain the defined objectives of economic growth and price stability by using the tools of OMO, VRRR and various interest rates  in the normal course of economic cycle.

Unconventional monetary policy:

 According to RBI’s Deepak Mohanty, “When central banks look beyond their traditional instrument of policy interest rate, monetary policy takes an unconventional character.”

 

Expansionary vs Contractionary Monetary Policy:

Expansionary monetary policy: It increases the money supply /liquidity in the financial system in order to lower unemployment, boost private-sector borrowing and consumer spending, and hence  stimulating the economic growth. It is also said to be cheap money policy. It is also said to be accommodative stance of RBI.

Contractionary Monetary Policy:

Contractionary monetary policy slows the rate of growth in the money supply /liquidity in the financial system or outright decreases the money supply in order to control inflation. It is also said to be hawkish stance. Contractionary monetary policy can slow economic growth, increase unemployment and depress borrowing and spending by consumers and businesses. Money supply during contractionary policy is said to be dear money policy.

 

Nature of Money:

Cheap Money:

During the expansionary monetary policy, money is available at cheaper rates because overall interest rates are low. Cheap money is good for borrowers as it is available at cheaper rates .

Dear Money:

During the Contractionary monetary policy, money is available at costly rates because overall interest rates are high. Dear money is bad for borrowers, as it is available at dearer rates.