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.
