Macroeconomics Project

MACROECONOMICS PROJECT SEMISTER-III
HARSH VAGAL SYBA-2377

MACROECONOMICS PROJECT- SEMISTER III
STUDY OF INDIAN MONETORY POLICY AND REGULATION OF

INDIAN ECONOMY – CONCEPTS ACCEPTED BY INDIAN
ECONOMY FOR MONEY SUPPLY AND REGULATION
NAME- HARSH VAGAL
CLASS- SYBA
SEMISTER -III
DIVISION- B
ROLL NUMBER- 2377
TIOPIC- STUDY OF INDIAN MONETORY POLICY AND

REGULATION OF INDIAN ECONOMY – CONCEPTS ACCEPTED BY
INDIAN ECONOMY FOR MONEY SUPPLY AND REGULATION
DATE- 20-10-2020
1
CERTIFICATE
This is to certify that,
HARSH VAGAL Of Class SYBA-B (2377) have
successfully completed the project Study of STUDY OF

INDIAN MONETORY POLICY AND REGULATION OF INDIAN
ECONOMY – CONCEPTS ACCEPTED BY INDIAN ECONOMY FOR
MONEY SUPPLY AND REGULATION respectively under the
guidance of
MRS. VARSHA MALWADE
during the academic year 2020-21
2
ACKNOWLEDGEMENT
I wish to express our sincere gratitude

towards Governor of the Reserve Bank of Inda
Mr. SHAKTIKANTI DAS for providing me an
opportunity to conduct my project
research at their respective firms. I sincerely thank
various books in libraries which helped me collect
information for the project. I also thank various internet
sources which helped me understand the concepts
mentioned in the project.
3
INDEX OF THE PROJECT

SR SUBTOPIC TITILE PG
NO. NO.
1 INTRODUCTION TO THE INDIAN MONITORY POLICY 3
2 WHY I CHOSE THIS TOPIC? – SIGNIFIANCE OF 4
INDIAN MONETORY POLICY AND ECONOMY .
3 MONETORY POLICY ALSO AFFECTS THE ECONOMY 4

BY CHANGING THE AGGREGATE DEMAND
4 BRIEF HISTORY OF INDIAN MONITORY POILICY 5

AND ITS REGULATION
5 OBJECTIVES OF INIDAN MONITORY POLICY 5

6 INDIAN ECONOMY’S ECONMIC REFORMS (1991 7
AND 2020)
7 TARGETS AND INDICATORS OF INDIAN MONETARY 10

POLICY
8 ROLE OF INDIAN ECONOMIC POLICY IN INDIA 11

ECONOMY
9 FRAMEWORK OF INDIAN MONITORY POLICY. 12

10 SCHEMATIC REPRESENTATION OF INDIAN 14
MONITORY FRAMEWORK
11 INSTRUMENTS OF MONETARY POLICY IN INDIA 14

12 KEY FIGURES AS PER MAY 2020 16
13 EFFECTIVENESS OF MONETORY POLICY IN INDIA 17
14 REGULATION OF INDIAN ECONOMY (2020- 17
ECONOMICAL AND FINANCIAL DEVEOPMENTS)
15 CONCEPTS ACCEPTED BY INDIAN ECONOMY 19

FOR MONEY SUPPLY AND REGULATION AS PER
INDIAN MONETORY POLICY
16 THE STANDARD CONCEPT OF MONEY SUPPLY 20

IN INDIAN MONETORY POLICY, INCLUDES THE
FOLLOWING TWO ELEMENTS
17 FOUR MESURES OF MONEY SUPPLY OF RBI: 21

18 OVERALL CONCLUSION OF STUDY OF 25
INDIAN MONETORY POLICY AND
REGULATION OF INDIAN ECONOMY
19 CONCLUSION TO MONEY SUPPLY THROUGH 27

INDIAN MONETARY POLICY.
20 BIBLOGRAPHY 29
4
INTRODUCTION TO THE INDIAN MONITORY POLICY

In India, the Monetary Policy is an important tool for the economic management of the
country. The Reserve Bank of India (RBI) is the central bank of the monetary authority of
India. it controls the supply of money and bank credit. It is responsible for ensuring that the
banking system meets the legitimate credit requirements and not for unproductive or
speculative reasons. Monetary policy is the macroeconomic policy laid down by the central
bank. It involves management of money supply and interest rate and is the demand side
economic policy used by the government of a country to achieve macroeconomic objectives
like inflation, consumption, growth and liquidity. In India, monetary policy of the Reserve
Bank of India is aimed at managing the quantity of money in order to meet the requirements
of different sectors of the economy and to increase the pace of economic growth.
The RBI implements the monetary policy through open market operations, bank rate policy,
reserve system, credit control policy, moral persuasion and through many other instruments.
Using any of these instruments will lead to changes in the interest rate, or the money supply
in the economy. Monetary policy can be expansionary and contractionary in nature.
Increasing money supply and reducing interest rates indicate an expansionary policy. The
reverse of this is a contractionary monetary policy. For instance, liquidity is important for an
economy to spur growth. To maintain liquidity, the RBI is dependent on the monetary policy.
By purchasing bonds through open market operations, the RBI introduces money in the
system and reduces the interest rate.
Monetary Policy has been defined differently by various economists. According to Paul
Einzig, Monetary Policy includes all monetary decisions and measures irrespective of
whether their aims are monetary or non-monetary and all non-monetary decisions and
measures that aim at affecting the monetary system. Harry Johnson defines monetary policy
as, policy employing central banks control of the supply of money as an instrument for
achieving the objectives of general economic policy. According D Jha, Monetary Policy is
one important segment of an overall financial policy which has to be operated in the overall
milieu prevailing in the country. Reserve Bank of India considers monetary policy for the use
of instruments within the control of central bank to influence the level of aggregate demand
for goods and services. Central banking instruments of control operate through varying the
cost and availability of credit money, those producing desired changes in the asset pattern of
credit institutions primarily the commercial banks. Thus, RBI is relatively more explicit in
defining the monetary policy. The aim of monetary policy in the initial years of inception of
RBI was mainly to maintain the sterling parity, with exchange rate being the nominal anchor
of monetary policy. Liquidity was regulated through open market operations, bank rate and
cash reserve ratio (CRR). Soon after independence and through the late years of 1960s, the
role of the central bank was aligned with the planned development process of the nation in
accordance with the 5-year plans. Thus, it played a major role in regulating credit availability,
employing OMOs, bank rate, and reserve requirement towards this end. With the
nationalization of major banks in 1969, the main objective of monetary policy through the
5
1970s till the mid-1980s was the regulation of credit in accordance with the developmental
needs of the country. This period was marked by monetization of fiscal deficit while
inflationary consequences of high public expenditure necessitated frequent recourse to CRR.
WHY I CHOSE THIS TOPIC? – SIGNIFIANCE OF INDIAN MONETORY POLICY

AND ECONOMY.
Monetary Policy is an arm of Public Policy. It is a process by which the government, central
bank or monetary authority manage the supply of money or trading in foreign exchange
markets. It rests on the relationship between the rates of interest in an economy that is the
price at which money can be borrowed and the total supply of money. It, thus, has set
objectives and priorities, which are derived from the respective mandates of central banks. It
ranges from a single objective of price stability considered to be the dominant objective of
monetary policy, to multiple objectives that also include growth and financial stability.
Monetary Policy is an important aspect of overall economic policy. An appropriate monetary
policy contributes to economic growth by adjusting money supply to the needs of growth, by
directing the flow of funds in the required channels and by providing institutional facilities
for credit in specific fields of economic activities. In this way, monetary policy helps a
healthy growth of the economy. Monetary Policy consists of the measures taken by the
central banking authority to regulate the cost and availability of credit.
MONETORY POLICY ALSO AFFECTS THE ECONOMY BY CHANGING THE
AGGREGATE DEMAND
Monetary policy impacts the money supply in an economy, which influences interest rates
and the inflation rate. It also impacts business expansion, net exports, employment, the cost
of debt, and the relative cost of consumption versus saving all of which directly or indirectly
impact aggregate demand.
Monetary policy is enacted by central banks by manipulating the money supply in an
economy. The money supply influences interest rates and inflation, both of which are major
determinants of employment, cost of debt, and consumption levels.
Expansionary monetary policy involves a central bank either buying Treasury notes,
decreasing interest rates on loans to banks, or reducing the reserve requirement. All of these
actions increase the money supply and lead to lower interest rates. This creates incentives for
banks to loan and businesses to borrow. Debt-funded business expansion can positively
affect consumer spending and investment through employment, thereby increasing aggregate
demand. Expansionary monetary policy also typically makes consumption more attractive
relative to savings. Exporters benefit from inflation as their products become relatively
cheaper for consumers in other economies. Contractionary monetary policy is enacted to halt
exceptionally high inflation rates or normalize the effects of expansionary policy. Tightening
the money supply discourages business expansion and consumer spending and negatively
impacts exporters, which can reduce aggregate demand.
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BRIEF HISTORY OF INDIAN MONITORY POILICY AND ITS REGULATION
Monetary Policy is as old as monetary system or as money itself. It has a long and chequered
history since the days of mercantilism. Evidence proves the existence of monetary
management in Greece. But before 1914, the whole thinking about monetary policy was
based upon the idea of automatic gold exchange system. After World War I, the gold
exchange standard collapsed, and it is then the modern genesis. of monetary policy took
place. The 1920s inflation in Germany, and the two international conferences, one in Brussels
in 1920 and the other one in Geneva in 1922, compelled the thinking about a new monetary
system. The depression of the 1930s provided further stimulus to the thinking of reforms in
the field of monetary management. The horizon of monetary policy has greatly widened in
the recent past. The origin of monetary management in India can be traced back to time
immemorial. The reference about the Panis, the moneylenders of Southern India, in Rig Veda
is an evidence of the developed state of banking or credit system in the vedic age, although
the date of the origin of the coins and credit instruments is lost in the midst of antiquity. In the
Mauryan era, the system of currency, credit and coinage was fully developed. Kautilya
devotes a chapter in his classical book the Arthashastra on rules for mining and credit. The
history of monetary management and policy in terms of central banking practices in India can
be traced to as far back as January 1773, when Lord Hastings, the then Governor, and later
on, the first Governor General of British India, placed before the Board of Revenue his plan
for General Bank in Bengal and Bihar. The Royal Commission on Indian Finance and
Currency also known as the Chamberlain Commission was set up in 1913 with J M Keynes
as one of the members who prepared a blueprint for the establishment of an Imperial Bank of
India.11 The bank came into existence on January 1921 by amalgamating the three
presidency banks as a commercial bank with some of the functions of the central bank also.
In August 1925, the Royal Commission on Indian Currency and Finance also referred the
Hilton Young Commission was appointed. The Commission observed that India was the only
big trading country in which the currency and note issues were under direct government
control. It recommended several measures to reform the monetary system. With the
recommendations of the Young Commission 12 and the Central Banking Enquiry Committee
the Reserve Bank of India was established through Reserve Bank of India Act, 1934
OBJECTIVES OF INIDAN MONITORY POLICY

1. Price Stability -This has been a dominant objective of monetary policy. Fluctuations in the
prices bring uncertainty and instability to the economy. Rising and falling prices are both not
desirable because they bring unnecessary loss to some and undue advantage to others.
Therefore, in this context monetary policy has assumed paramount importance. It aims at
preventing maladjustments, that is, at eliminating the causes of recession. To achieve this,
investment finance has to be regulated through appropriate variations in the rate of interest in
the capital market. Rate of interest is a vital link that connects the volume of money and
investment in a given economy. A Policy of price stability keeps the value of money stable,
eliminates cyclical fluctuations, brings economic stability, helps in reducing inequalities of
income and wealth, secures social justice and promotes economic welfare. However, there
are certain difficulties in pursuing a policy of stable price level. The problem is deciding the
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type of price level to be stabilised. There is no specific criterion with regard to the choice of a
price level. Innovations may reduce the cost of production, but a policy of stable prices may
bring larger profits to producers at the cost of consumers and wage earners. Again, in an open
economy which imports raw materials and other intermediate products at high prices, the cost
of production of domestic goods will be high. Thus, a policy of stable prices will reduce
profits and retard further investment. Under these circumstances, a policy of stable prices is
not only inequitable but also conflicts with economic growth. Therefore, price stability means
stability of some appropriate price index in the sense that we can detect no definite upward
trend in the index after making proper allowance for the upward bias inherent in all price
index. Price stability can be maintained by following a counter-cyclical monetary policy, that
is easy monetary policy during a recession and a dear monetary policy during a boom. In a
nutshell, both inflation and deflation need to be regulated appropriately by the central bank.
2. Economic Growth -This objective of monetary policy has acquired considerable
significance in recent years. Economic growth is defined as the process whereby the real per
capita income of the country increases over a long period of time. Monetary policy can lead
to economic growth, by having a control on the interest rate which is inversely related to
investment. By following an easy credit policy and lowering interest rates, the level of
investment can be raised which promotes economic growth. Monetary policy also contributes
towards growth by helping in maintaining the stability of income and prices. By moderating
economic fluctuations and avoiding depression, monetary policy helps in achieving the
growth objective. Because fluctuations in the rates of inflation have an adverse impact on
growth and monetary policy also helps in controlling hyperinflation. Moreover, tight
monetary policy affects small firms more in comparison to large firms, and higher interest
rates have greater impact on small investments in comparison to large industrial investment.
So, monetary policy needs to be formulated in the way that it may encourage investment and
simultaneously control inflation in order to enhance growth and put a control on economic
fluctuations.
3. Full Employment- Full-Employment is the ultimate objective of monetary policy.
According to Keynes, "full employment means the absence of involuntary unemployment".15
That is full employment is a situation in which everybody who is willing to work and able to
work gets work and achieves this, Keynes advocated increase in effective demand. Burner
(1961) considers "full employment is a situation where all qualified persons who want jobs at
current wage rate, find full time jobs.
4. Balance of Payments Equilibrium -- This objective of monetary policy has emerged
since the 1950s. The emergence of this objective is due to the phenomenal growth in global
trade as against the growth of international liquidity. A deficit in the balance of payments is
said to retard the attainment of other objectives as it reflects excessive money supply in the
economy. As a result, people exchange their excess money holdings for foreign goods and
securities. Under a system of fixed exchange rates, the central bank will have to sell foreign
exchange reserves and buy the domestic currency for eliminating excess supply of domestic
currency. This is how equilibrium will be restored in the balance of payments. If the money
supply is below the existing demand for money at the given exchange rate, there will be a
surplus in the balance of payments. Consequently, people acquire the domestic currency by
selling goods and securities to foreigners.
8
INDIAN ECONOMY’S ECONMIC REFORMS (1991 AND 2020)

Fiscal Reforms 1991: A key element in the stabilization effort was to restore fiscal
discipline. The data reveals that fiscal deficit during 1990-91 was as large as 8.4 percent of
GDP. The budget for 1991-92 took a bold step in the direction of correcting fiscal imbalance.
It envisaged a reduction in fiscal deficit by nearly two percentage points of GDP from 8.4
percent in 1990-91 to 6.5 percent in 1991-92.
The budget aimed at containing government expenditure and augmenting revenues; reversing
the downtrend in the share of direct taxes to total tax revenues and curbing conspicuous
consumption. Some of the important policy initiatives introduced in the budget for the year
1991-92 for correcting the fiscal imbalance were: reduction in fertilizer subsidy, abolition of
subsidy on sugar, disinvestment of a part of the government’s equity holdings in select public
sector undertakings, and acceptance of major recommendations of the Tax Reforms
Committee headed by Raja Chelliah. These recommendations aimed to raise revenue through
better compliance in case of income tax and excise and customs duties and make the tax
structure stable and transparent.
Monetary and Financial Sector Reforms (1991): Monetary reforms aimed at doing away
with interest rate distortions and rationalizing the structure of lending rates.
● Reserve Requirements: reduction in statutory liquidity ratio (SLR) and the cash reserve
ratio (CRR) in line with the recommendations of the Narasimham Committee Report,
1991. In mid-1991, SLR and CRR were very high. It was proposed to cut down the
SLR from 38.5 percent to 25 percent within a time span of three years. Similarly, it
was proposed that the CRR brought down to 10 percent (from the earlier 25 percent)
over a period of four years
● Interest Rate Liberalisation: Earlier, RBI controlled the rates payable on deposits of
different maturities and also the rates which could be charged for bank loans which
varied according to the sector of use and also the size of the loan. Interest rates on time
deposits were decontrolled in a sequence of steps beginning with longer term deposits,
and liberalisation was progressively extended to deposits of shorter maturity
● Greater competition among public sector, private sector and foreign banks and
elimination of administrative constraints
● Liberalisation of bank branch licensing policy in order to rationalize the existing branch
network
● Banks were given freedom to relocate branches and open specialized branches ●
Guidelines for opening new private sector banks
● New accounting norms regarding classification of assets and provisions of bad debt
were introduced in tune with the Narasimham Committee Report
● Reforms in Capital Markets: Recommendations of the Narasimham Committee were

initiated in order to reform capital markets, aimed at removing direct government
control and replacing it with a regulatory framework based on transparency and
disclosure supervised by an independent regulator. The Securities & Exchange Board
of India (SEBI) which was set up in 1988 was given statutory
9
recognition in 1992 on the basis of recommendations of the Narasimham Committee.
SEBI has been mandated to create an environment which would facilitate
mobilization of adequate resources through the securities market and its efficient
allocation.
● Industrial Policy Reforms: In order to consolidate the gains already achieved during
the 1980s, and to provide greater competitive stimulus to the domestic industry, a
series of reforms were introduced in the Industrial Policy. The government announced
a New Industrial Policy on 24 July 1991. The New Industrial Policy established in
1991 sought substantially to deregulate industry so as to promote growth of a more
efficient and competitive industrial economy. The central elements of industrial policy
reforms were as follows:
o Industrial licensing was abolished for all projects except in 18 industries. With
this, 80 percent of the industry was taken out of the licensing framework.
o The Monopolies & Restrictive Trade Practices (MRTP) Act was repealed to
eliminate the need for prior approval by large companies for capacity
expansion or diversification.
o Areas reserved for the public sector were narrowed down and greater
participation by private sector was permitted in core and basic industries. The
new policy reduced the number of areas reserved from 17 to 8. These eight are
mainly those involving strategic and security concerns. (Example, railways,
atomic energy etc.)
o The policy encouraged disinvestment of government holdings of equity share
capital of public sector enterprises.
o The public sector units were provided greater autonomy and professional
management that could be helpful for generating reasonable profits, through an
MOU(Memorandum of Understanding) between the enterprise and the
concerned Ministry, through which targets that the enterprise had to achieve
were set up.
Promoting Foreign Investment: The government took several measures to promote foreign
investment in India in the post-reform period. Some of the important measures are:
● In 1991, the government announced a specified list of high technology and

high-investment priority industries wherein automatic permission was granted for
foreign direct investment (FDI) up to 51 percent foreign equity. The limit was raised
to 74 percent and subsequently to 100 percent for many of these industries. Moreover,
many new industries have been added to the list over the years.
● Foreign Investment Promotion Board (FIPB) has been set up to negotiate with
international firms and approve direct foreign investment in select areas. ● Steps were
also taken from time to time to promote foreign institutional investment (FII) in India.
2020 ECONOMIC REFORMS

Economic activity.
10
In response to the public health emergency precipitated by the spread of COVID-19, many
protective measures were adopted to limit the transmission of the virus. These
social-distancing measures effectively closed parts of the economy, resulting in a sudden and
unprecedented fall in economic activity and historic increases in joblessness. Although virus
mitigation efforts in many places did not begin until the final two weeks of March, real
personal consumption expenditures (PCE) plummeted 6.7 percent in March and an
unprecedented 13.2 percent in April. Indicators suggest spending rose in May, but the April
data and May indicators taken together point to a collapse in second-quarter real PCE.
Likewise, in the housing market, residential sales and construction in April posted outsized
declines that are close to some of the largest ever recorded, and heightened uncertainty and
weak demand have led many businesses to put investment plans on hold or cancel them
outright. These data, along with other information, suggest that real gross domestic product
will contract at a rapid pace in the second quarter after tumbling at an annual rate of 5 percent
in the first quarter of 2020.
Inflation.
Consumer price inflation has slowed abruptly. The 12-month change in the price index for
PCE was just 0.5 percent in April. The 12-month measure of PCE inflation that excludes food
and energy items (so-called core inflation), which historically has been a better indicator of
where overall inflation will be in the future than the total figure, fell from 1.8 percent in
February to 1.0 percent in April. This slowing reflected monthly readings for March and April
that were especially low because of large price declines in some categories most directly
affected by social distancing. Overall inflation also has been held down by substantially lower
energy prices, which more than offset the effects of surging prices for food. Despite the sharp
slowing in 2 Summary inflation, survey-based measures of longer run inflation expectations
have generally been stable at relatively low levels. However, market-based measures of
inflation compensation have moved down to some of the lowest readings ever seen.
Financial stability.
The COVID-19 pandemic has abruptly halted large swaths of economic activity and led to
swift financial repercussions. Despite increased resilience from the financial and regulatory
reforms adopted since 2008, financial system vulnerabilities—most notably those associated
with liquidity and maturity transformation in the nonbank financial sector—have amplified
some of the economic effects of the pandemic. Accordingly, financial-sector vulnerabilities
are expected to be significant in the near term. The strains on household and business balance
sheets from the economic and financial shocks since March will likely create persistent
fragilities. Financial institutions may experience strains as a result. The Federal Reserve, with
approval of the Secretary of the Treasury, established new credit and liquidity facilities under
section 13(3) of the Federal Reserve Act to alleviate severe dislocations that arose in a
number of financial markets and to support the flow of credit to households, businesses, and
state and local governments. Furthermore, as financial stresses abroad risked spilling over
into U.S. credit markets, the Federal Reserve and several other central banks announced the
expansion and enhancement of dollar liquidity swap lines. In addition, the Federal Reserve
introduced a new temporary repurchase agreement facility for foreign monetary authorities.
The Federal Reserve has also made a number of adjustments to its regulatory and supervisory
regime to facilitate market functioning and reduce regulatory impediments to banks
supporting households, businesses, and municipal customers affected by COVID-19.
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Financial conditions.
In late February and over much of March as COVID-19 spread, equity prices plunged and
nominal Treasury yields dropped substantially, with yields on longer-term securities reaching
all-time record lows. Spreads of yields on corporate bonds over those on
comparable-maturity Treasury securities widened significantly as the credit quality of firms
declined and market functioning deteriorated; in addition, loans were unavailable for most
firms, particularly firms below investment grade. At the most acute phase of this period,
trading conditions became extremely illiquid and some critical markets stopped functioning
properly. Consumer borrowing also fell as spending slumped. Several markets supporting
consumer lending experienced severe strains around this period, including the agency
residential mortgage-backed securities (MBS) market as well as the auto, credit card, and
student loan securitization markets. In response, the Federal Reserve took unprecedented
measures to restore smooth market functioning and to support the flow of credit in the
economy, including the creation of a number of emergency credit and liquidity facilities.1
These actions, along with the aggressive response of fiscal policy, stabilized financial markets
and led to a notable improvement in financial conditions for both firms and households as
well as state and local governments. Even so, lending standards for both households and
businesses have become less accommodative, and borrowing conditions are tight for low
rated households and businesses.
Targets and Indicators of Indian Monetary Policy
The choice of targets and indicators of monetary policy are based on the objectives of
monetary policy. There are three targets of monetary policy; money supply, availability of
credit and interest rates. The central bank cannot directly control output prices; hence it
selects the growth rate of money supply as an intermediate target. Friedman suggests that the
money supply should be allowed to grow steadily at the rate of 3 to 4% per annum for a
smooth growth of the economy and to avoid inflationary and recessionary tendencies. The
availability of credit, and interest rates are the other two target variables of monetary policy.
They are often referred to as the "money market conditions". The monetary authority can
influence the short-term interest rates. It can change credit conditions and affect economic
activity by rationing of credit or other means. The central bank influences economic activity
by following an easy or expansionary monetary policy through reducing short-term interest
rates and a tight or contractionary monetary policy through rising short-term interest rates.
Money supply and interest rate are intermediate targets of monetary policy. They are also the
competing targets, as the central bank faces a trade off as it can aim either at increasing the
money supply or maintaining a level of interest rate. By targeting money interest rate, it
would be neglecting money supply. The general consensus of economists and policy makers
is towards money supply as it is measurable, while there are a variety of interest rates. The
money supply linkage with nominal GNP is more direct and predictable than the interest
linkage with nominal GNP of the nation.
MONITORY TARGETING IN INDIA- OPERATIONG FRAMEWORK 12

ROLE OF INDIAN ECONOMIC POLICY IN INDIA ECONOMY
ROLE OF MONETARY POLICY
The monetary policy in a developing economy will have to be quite different from that of a
developed economy mainly due to different economic conditions and requirements of the two
types of economies. A developed country may adopt full employment or price stabilization or
exchange stability as a goal of the monetary policy. But in a developing or underdeveloped
country, economic growth is the primary and basic necessity. Thus, in a developing economy
the monetary policy should aim at promoting economic growth, the monetary authority of a
developing economy can play a vital role by adopting such a monetary policy which creates
conditions necessary for rapid economic growth. Monetary policy can serve the following
developmental requirements of developing economies. EG:INDIA
1. Developmental Role:
• In a developing economy, the monetary policy can play a significant role in accelerating
economic development by influencing the supply and uses of credit, controlling inflation, and
maintaining balance of payment.
* Once development gains momentum, effective monetary policy can help in meeting the
requirements of expanding trade and population by providing elastic supply of credit
2. Creation and Expansion of Financial Institutions:
* The primary aim of the monetary policy in a developing economy must be to improve its
currency and credit system. More banks and financial institutions should be set up,
particularly in those areas which lack these facilities.
• The extension of commercial banks and setting up of other financial institutions like saving
banks, cooperative saving societies, mutual societies, etc. will help in increasing credit
facilities, mobilizing voluntary savings of the people, and channelizing them into productive
uses.
13
• It is also the responsibility of the monetary authority to ensure that the funds of the
institutions are diverted into priority sectors or industries as per requirements of are
development plan of the country.
3. Effective Central Banking:
• To meet the developmental needs the central bank of an developing country must function
effectively to control and regulate the volume of credit through various monetary instruments,
like bank rate, open market operations, cash-reserve ratio etc.
• Greater and more effective credit controls will influence the allocation of resources by
diverting savings from speculative and unproductive activities to productive uses.
4. Maintaining Equilibrium in Balance of payments
Balance of Payments: • The monetary policy in a developing economy should also solve the
problem of adverse balance of payments. Such a problem generally arises in the initial stages
of economic development when the import of machinery, raw material, etc., increase
considerably, but the export may not increase to the same extent.
• The monetary authority should adopt direct foreign exchange controls and other measures to
correct the adverse
5.10. Controlling Inflationary
• Developing economies are highly sensitive to inflationary pressures. Large expenditures on

developmental schemes increase aggregate demand. But, output of consumer's goods does not
increase in the same proportion. This leads to inflationary rise in prices. Thus, the monetary
policy in a developing economy should serve to control inflationary tendencies by increasing
savings by the people, checking expansion of credit by the banking system, and discouraging
balance of payments.
6. Debt Management:
• Debt management is another function of monetary policy in a developing country. Debt

management aims at (a) deciding proper timing and issuing of government bonds, (b)
stabilizing their prices, and (c) minimizing the cost of servicing public debt.
• The monetary authority should conduct the debt management in such a manner that
conditions are created "in which public borrowing can increase from year to year and on a big
scale without giving any jolt to the system.
• And this must be on cheap rates to keep the burden of the debt low. "However, the success
of debt management requires the existence of a well-developed money and capital market
along with a variety of short-term and long-term
7. Integration of organized and unorganized money market
Most developing countries are characterized by dual monetary system in which a small but
highly organized money market on the one hand and large but unorganized money market on
14
the other hand operate simultaneously. The unorganized money market remains outside the
control of the central bank. By adopting effective measures, the monetary authority should
integrate the unorganized and organized sectors of the money market.
8. Integrated Interest Rate Structure:
• In an underdeveloped economy, there is absence of an integrated interest rate structure.

There is wide disparity of interest rates prevailing in the different sectors of the economy and
these rates do not respond to the changes in the bank rate, thus making the monetary policy
ineffective.
• The monetary authority should take effective steps to integrate the interest rate structure of
the economy. Moreover, a suitable interest rate structure should be developed which not only
encourages savings and investment in the country but also discourages speculative and
unproductive loans.
FRAMEWORK OF INDIAN MONITORY POLICY.
The monetary policy framework in India has evolved over the past few decades in response
to financial developments and changing macroeconomic conditions. The operational
framework of monetary policy has also gone through significant changes with respect to
instruments and targeting mechanisms. The preamble of the Reserve Bank of India Act, 1934
was also amended in 2016, which now clearly provides the mandate of the RBI. It reads as
follows:
The aim of monetary policy in the initial years of inception of RBI was mainly to maintain
the sterling parity, with exchange rate being the nominal anchor of monetary policy. Liquidity
was regulated through open market operations, bank rate and cash reserve ratio (CRR). Soon
after independence and through the late 1960s, the role of the central bank was aligned with
the planned development process of the nation in accordance with the 5-year plans. Thus, it
played a major role in regulating credit availability, employing open market operations, bank
rate, and reserve requirement towards this end.With the nationalization of major banks in
1969, the main objective of Indian monetary policy through the 1970s till the mid-1980s was
the regulation of credit in accordance with the developmental needs of the country. This
period was marked by monetization of fiscal deficit while inflationary consequences of high
public expenditure necessitated frequent recourse to CRR. In 1985, on the recommendation of
the Committee set up to Review the Working of the Monetary System (Chairman: Dr.
Sukhamoy Chakravarty), a new Indian monetary policy framework, monetary targeting with
feedback was implemented based on empirical evidence of a stable demand for money
function. However, financial innovations in the 1990s implied that demand for money may be
affected by factors other than income. Further, interest rates were deregulated in the
mid-1990s and the Indian economy was getting increasingly integrated with the global
economy. Therefore, the RBI began to deemphasize the role of monetary aggregates and
implemented a multiple indicator approach to monetary policy in 1998 encompassing all
economic and financial variables that influence the major objectives outlined in the Preamble
of the RBI Act. This was done in two phases—initially MIA and later augmented MIA which
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included forward looking variables and time series models.Based on RBI’s Report of the
Expert Committee to Revise and Strengthen the Indian Monetary Policy Framework (2014,
Chairman: Dr Urjit R Patel), a formal transition was made in 2016 towards flexible inflation
targeting and a six member Monetary Policy Committee (MPC) was constituted for setting
the policy repo rate. The Indian Monetary Policy Framework Agreement (MPFA) was signed
between the Government of India and the RBI in February 2015 to formally adopt the
flexible inflation targeting framework. 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 FIT
framework. With this step towards modernization of the monetary policy process, India
joined the set of countries that adopted inflation targeting, starting from 1990 by New
Zealand, as their monetary policy framework. The Central Government notified in the
Official Gazette dated August 5, 2016, that the Consumer Price Index (CPI) inflation target
would be 4% with ± 2% tolerance band for the period from August 5, 2016 to March 31,
2021. At the time of writing (April 2020), this period is drawing to a close in less than a year.
In this backdrop, this paper discusses the evolution of the monetary policy framework in
India and describes the workings of the current framework. The paper is divided into the
following sections. Section 2 presents a schematic representation of the main components of
a general monetary policy framework and describes its key features. Section 3 describes the
genesis of the monetary policy framework in India since 1985 covering the Monetary
Targeting Framework, Multiple Indicator Approach and Flexible Inflation Targeting. The
main recommendations of RBI’s Report of the Expert Committee to Revise and Strengthen
the Monetary Policy Framework (2014, Chairman: Dr Urjit R Patel) are also discussed.
Composition, workings and voting pattern of the Monetary Policy Committee from October
2016 to March 2020 are also provided. Further, a comparison of voting patterns with various
countries across the globe is undertaken. Section 4 discusses a general framework for
monetary policy transmission and applies the framework to India. It also describes interest
rate linkages at the global level. Section 5 examines unconventional monetary policy
measures adopted in late 2019 and early 2020. Section 6 concludes the paper.
SCHEMATIC REPRESENTATION OF INDIAN MONITORY FRAMEWORK
Instruments are tools that the central bank has control over and are used to achieve the
operational target. Examples of instruments include open market operations, reserve
requirements, discount policy, lending to banks, policy rate. Operational targets are the
financial variables that can be controlled by the central bank to a large extent through the
monetary policy instruments and guide the day-to-day operations of the central bank. These
can impact the intermediate target and thus help in the delivery of the final goal of monetary
policy. Examples of operational targets include reserve money and short-term money market
interest rates. Intermediate targets are variables that are closely related with the final goals of
monetary policy and can be affected by monetary policy. Intermediate targets may include
monetary aggregates and short-term and long-term interest rates. Goals refer to the final
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policy objectives. These may include price stability, economic growth, financial stability and
exchange rate stability. This general framework is applied to the Indian monetary targeting
framework with feedback that prevailed from 1985 to 1998 and to the inflation targeting
framework that exists from 2016 onwards. The multiple indicator approach that was
operational from 1998 to 2016 was based on a number of financial and economic variables
and was not exactly specified on the basis of this framework although broad money was
treated as an intermediate target and the goals of monetary policy are the same across the
various frameworks.
INSTRUMENTS OF MONETARY POLICY IN INDIA
♣ Cash Reserve Ratio (CRR): The share of net demand and time liabilities deposits that
banks must maintain as cash balance with the Reserve Bank of India. Cash reserve ratio is a
certain percentage of bank deposits which banks are required to keep with RBI in the form of
reserves or balances. The higher the CRR with the RBI, the lower will be the liquidity in the
system, and vice versa. RBI is empowered to vary CRR between 15 percent and 3 percent.
Per the suggestion by the Narasimham Committee report, the CRR was reduced from 15% in
1990 to 5 percent in 2002. As of 9th October 2020, the CRR is 3.00 percent
♣ Statutory Liquidity Ratio (SLR): The share of net demand and time liabilities deposits
that banks must maintain in safe and liquid assets, such as, government securities, cash and
gold. Changes in SLR often influence the availability of resources in the banking system for
lending to the private sector. Every financial institution has to maintain a certain quantity of
liquid assets with themselves at any point of time of their total time and demand liabilities.
These assets have to be kept in non-cash form such as G-secs precious metals, approved
securities like bonds. The ratio of the liquid assets to time and demand liabilities is termed as
the Statutory liquidity ratio. There was a reduction of SLR from 38.5% to 25% because of the
suggestion by Narsimham Committee. As on 9th October 2020, the SLR stands at 18%
♣ Refinance Facilities: The sector-specific refinance facilities aim at achieving sector
specific objectives through provision of liquidity at a cost linked to the policy repo rate. The
Reserve Bank has, however, been progressively deemphasising sector specific policies as
they interfere with the transmission mechanism.
♣ Liquidity Adjustment Facility (LAF): This consists of overnight and term repo/reverse
repo auctions. The RBI has progressively increased the proportion of liquidity injected in the
LAF through term-repos.
♣ Term Repos: The term repos are introduced by the RBI since October 2013. They are of
different tenors (such as 7/14/28 days). They are used to inject liquidity over a period that is
longer than overnight. The aim of term repo is to help develop inter-bank money market,
which in turn, can set market-based benchmarks for pricing of loans and deposits, and
through that improve transmission of monetary policy.
♣ Marginal Standing Facility (MSF): A facility under which scheduled commercial banks can
borrow additional amount of overnight money from the Reserve Bank by dipping into their
SLR portfolio up to a limit (currently two percent of their net demand and time liabilities
deposits ) at a penal rate of interest (currently 100 basis points above the repo rate). This
provides a safety valve against unanticipated liquidity shocks to the banking system. MSF
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rate and reverse repo rate determine the corridor for the daily movement in short-term money
market interest rates.
♣ Open Market Operations (OMOs): These include both, outright purchase or sale of
government securities (for injection /absorption of liquidity).
♣ Bank Rate: It is the rate at which the RBI is ready to buy or rediscount bills of exchange
or other commercial papers of commercial banks. This rate has been aligned to the MSF rate
and, therefore, changes automatically as and when the MSF rate changes alongside policy
repo rate changes. The bank rate, also known as the discount rate, is the rate of interest
charged by the RBI for providing funds or loans to the banking system. This banking system
involves commercial and co-operative banks, Industrial Development Bank of India, IFC,
EXIM Bank, and other approved financial institutions. Funds are provided either through
lending directly or discounting or buying money market instruments like commercial bills
and treasury bills. Increase in bank rate increases the cost of borrowing by commercial banks
which results in the reduction in credit volume to the banks and hence the supply of money
declines. Increase in the bank rate is the symbol of tightening of RBI monetary policy. As of
9th October 2020, the bank rate is 4.25 percent.
♣ Market Stabilisation Scheme (MSS): The instrument for monetary management was
introduced in 2004. Surplus liquidity of a more enduring nature arising from large capital
inflows is absorbed through sale of short-dated government securities and treasury bills. The
mobilised cash is held in a separate government account with the RBI. The instrument thus
has features of both SLR and CRR. The Reserve Bank of India seeks to influence monetary
conditions through management of Liquidity by operating in varied instruments. Since 1991,
the market environment has been deregulated and liberalised where in the interest rates are
largely determined by the market forces.
♣ Credit ceiling
In this operation, RBI issues prior information or direction that loans to the commercial banks
will be given up to a certain limit. In this case, commercial bank will be tight in advancing
loans to the public. They will allocate loans to limited sectors. A few examples of credit
ceiling are agriculture sector advances and priority sector lending
Credit authorisation scheme

Credit authorisation scheme was introduced in November 1965 when P C Bhattacharya was
the chairman of RBI. Under this instrument of credit regulation, RBI, as per the guideline,
authorise the banks to advance loans to desired sectors
♣ Moral suasion
Moral suasion is just as a request by the RBI to the commercial banks to take certain actions
and measures in certain trends of the economy. RBI may request commercial banks not to
give loans for unproductive purposes which do not add to economic growth but increase
inflation.
♣ Repo rate and reverse repo rate

Repo rate is the rate at which RBI lends to its clients generally against government securities.
Reduction in repo rate helps the commercial banks to get money at a cheaper rate and
increase in repo rate discourages the commercial banks to get money as the rate increases and
18
becomes expensive. The reverse repo rate is the rate at which RBI borrows money from the
commercial banks. The increase in the repo rate will increase the cost of borrowing and
lending of the banks which will discourage the public to borrow money and will encourage
them to deposit. As the rates are high the availability of credit and demand decreases
resulting to decrease in inflation. This increase in repo rate and reverse repo rate is a symbol
of tightening of the policy. As of May 2020, the repo rate is 4.00% and the reverse repo rate
is 3.35%. KEY FIGURES AS PER MAY 2020
Effectiveness of Monetary Policy in India

The Reserve Bank of India Act, (1934) sets out the central bank's objectives as, "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".
This broad guideline makes the objectives of monetary policy clear. The New Economic
Policy (NEP) of 1991 was initiated to overcome the macroeconomic crisis. The NEP included
fiscal, monetary, industrial, trade sector reforms. Against this backdrop, there was a shift in
the framework of monetary policy from monetary targeting to a multiple indicators approach.
It was also necessary to test the effectiveness of monetary policy in ensuring stability and
financial development in the economy.
The data on variables like Wholesale Price Index, Net Bank Credit to the Government, Net
Foreign Assets of the Banking Sector are used as the monetary policy variables and Financial
Development Index constructed in the sixth chapter is used to represent financial
development in India. The Wholesale Price Index in India has a large coverage of
commodities and has high frequency release of data unlike the Consume Index in India. WPI
is a widely used price index in India by both analysts and policy makers to examine price
trends and is generally considered as an indicator of inflation in the economy. Therefore, WPI
is used as an index of domestic prices. The Net Bank Credit to the government is the sum of
Net RBI credit to the centre, Net RBI credit to the state governments and other banks' credit
to the government. It is the credit side indicator of the monetary policy. The Net Foreign
Assets of the banking sector refers to the sum of RBI's Net foreign assets and other banks'
foreign exchange assets. This has propelled the growth of reserve money and is a reflection of
the strong build-up of foreign exchange reserves, arising from improvements in the current
and capital accounts of the balance of payments.
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REGULATION OF INDIAN ECONOMY (2020- ECONOMICAL AND FINANCIAL
DEVEOPMENTS)
Economic activity.
In response to the public health emergency precipitated by the spread of COVID-19, many
protective measures were adopted to limit the transmission of the virus. These
social-distancing measures effectively closed parts of the economy, resulting in a sudden and
unprecedented fall in economic activity and historic increases in joblessness. Although virus
mitigation efforts in many places did not begin until the final two weeks of March, real
personal consumption expenditures (PCE) plummeted 6.7 percent in March and an
unprecedented 13.2 percent in April. Indicators suggest spending rose in May, but the April
data and May indicators taken together point to a collapse in second-quarter real PCE.
Likewise, in the housing market, residential sales and construction in April posted outsized
declines that are close to some of the largest ever recorded, and heightened uncertainty and
weak demand have led many businesses to put investment plans on hold or cancel them
outright. These data, along with other information, suggest that real gross domestic product
will contract at a rapid pace in the second quarter after tumbling at an annual rate of 5 percent
in the first quarter of 2020.
The labour markets

The severe economic repercussions of the pandemic have been especially visible in the
labour market. Since February, employers have shed nearly 20 million jobs from payrolls,
reversing almost 10 years of job gains. The unemployment rate jumped from a 50-year low of
3.5 percent in February to a post–World War II high of 14.7 percent in April and then moved
down to a still very elevated 13.3 percent in May. The most severe job losses have been
sustained by those with lower earnings and by the socioeconomic groups that are
disproportionately represented among low wage jobs.
Inflation.
Consumer price inflation has slowed abruptly. The 12-month change in the price index for
PCE was just 0.5 percent in April. The 12-month measure of PCE inflation that excludes food
and energy items (so-called core inflation), which historically has been a better indicator of
where overall inflation will be in the future than the total figure, fell from 1.8 percent in
February to 1.0 percent in April. This slowing reflected monthly readings for March and
April that were especially low because of large price declines in some categories most
directly affected by social distancing. Overall inflation also has been held down by
substantially lower energy prices, which more than offset the effects of surging prices for
food. Despite the sharp slowing in inflation, survey-based measures of long run inflation
expectations have generally been stable at relatively low levels. However, market-based
measures of inflation compensation have moved down to some of the lowest readings ever
seen.
Financial conditions.
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In late February and over much of March as COVID-19 spread, equity prices plunged and
nominal Treasury yields dropped substantially, with yields on longer-term securities reaching
all-time record lows. Spreads of yields on corporate bonds over those on
comparable-maturity Treasury securities widened significantly as the credit quality of firms
declined and market functioning deteriorated; in addition, loans were unavailable for most
firms, particularly firms below investment grade. At the most acute phase of this period,
trading conditions became extremely illiquid and some critical markets stopped functioning
properly. Consumer borrowing also fell as spending slumped. Several markets supporting
consumer lending experienced severe strains around this period, including the agency
residential mortgage-backed securities (MBS) market as well as the auto, credit card, and
student loan securitization markets. In response, the Federal Reserve took unprecedented
measures to restore smooth market functioning and to support the flow of credit in the
economy, including the creation of a number of emergency credit and liquidity facilities.1
These actions, along with the aggressive response of fiscal policy, stabilized financial
markets and led to a notable improvement in financial conditions for both firms and
households as well as state and local governments. Even so, lending standards for both
households and businesses have become less accommodative, and borrowing conditions are
tight for low rated households and businesses.
Financial stability.
The COVID-19 pandemic has abruptly halted large swaths of economic activity and led to
swift financial repercussions. Despite increased resilience from the financial and regulatory
reforms adopted since 2008, financial system vulnerabilities—most notably those associated
with liquidity and maturity transformation in the nonbank financial sector—have amplified
some of the economic effects of the pandemic. Accordingly, financial-sector vulnerabilities
are expected to be significant in the near term. The strains on household and business balance
sheets from the economic and financial shocks since March will likely create persistent
fragilities. Financial institutions may experience strains as a result. The Federal Reserve, with
approval of the Secretary of the Treasury, of credit to households, businesses, and state and
local governments. Furthermore, as financial stresses abroad risked spilling over into U.S.
credit markets, the Federal Reserve and several other central banks announced the expansion
and enhancement of dollar liquidity swap lines. In addition, the Federal Reserve introduced a
new temporary repurchase agreement facility for foreign monetary authorities. The Federal
Reserve has also made a number of adjustments to its regulatory and supervisory regime to
facilitate market functioning and reduce regulatory impediments to banks supporting
households, businesses, and municipal customers affected by COVID-19.
CONCEPTS ACCEPTED BY INDIAN ECONOMY FOR MONEY SUPPLY AND
REGULATION AS PER INDIAN MONETORY POLICY
What is the importance of money supply in Indian economy?
Growth of money supply is an important factor not only for acceleration of the process of
economic development but also for the achievement of price stability in the economy. There
must be controlled expansion of money supply if the objective of development with stability
is to be achieved. A healthy growth of an economy requires that there should be neither
inflation nor deflation. Inflation is the greatest headache of a developing economy. A mild
inflation arising out of the creation of money by deficit financing may stimulate investment
21
by raising profit expectations and extracting forced savings. But a runaway inflation is highly
detrimental to economic growth. The developing economies have to face the problem of
inadequacy of resources in initial stages of development and it can make up this deficiency
by deficit financing. But it has to be kept strictly within safe limits. Thus, increase in money
supply affects vitally the rate of economic growth. In fact, it is now regarded as a legitimate
instrument of economic growth. Kept within proper limits it can accelerate economic growth
but exceeding of the limits will retard it. Thus, management of money supply is essential in
the interest of steady economic growth. Before explaining the two components of money
supply two things must be noted with regard to the money supply in the economy. First, the
money supply refers to the total sum of money available to the public in the economy at a
point of time. That is, money supply is a stock concept in sharp contrast to the national
income which is a flow representing the value of goods and services produced per unit of
time, usually taken as a year. Secondly, money supply always refers to the amount of money
held by the public. In the term public are included households, firms and institutions other
than banks and the government. The rationale behind considering money supply as held by
the public is to separate the producers of money from those who use money to fulfil their
various types of demand for money. Since the Government and the banks produce or create
money for the use by the public, the money (cash reserves) held by them are not used for
transaction and speculative purposes and are excluded from the standard measures of money
supply. This separation of producers of money from the users of money is important from the
viewpoint of both monetary theory and policy
THE STANDARD CONCEPT OF MONEY SUPPLY IN INDIAN MONETORY

POLICY, INCLUDES THE FOLLOWING TWO ELEMENTS:
Currency with the Public:

In order to arrive at the total currency with the public in India we add the following
items:
1. Currency notes in circulation issued by the Reserve Bank of India.
2. The number of rupee notes and coins in circulation.
3. Small coins in circulation.
It is worth noting that cash reserves with the banks has to be deducted from the value of the
above three items of currency in order to arrive at the total currency with the public. This is
because cash reserves with the banks must remain with them and cannot therefore be used for
making payments for goods or by any commercial bank’s transactions. It may further be
noted that these days paper currency issued by Reserve Bank of India (RBI) are not fully
backed by the reserves of gold and silver, nor it is considered necessary to do so. Full backing
of paper currency by reserves of gold prevailed in the past when gold standard or silver
standard type of monetary system existed. According to the modern economic thinking the
magnitude of currency issued should be determined by the monetary needs of the economy
and not by the available reserves of gold and silver. In other developed countries, since 1957
Reserve Bank of India follows Minimum Reserve System of issuing currency. Under this
system, minimum reserves of Rs. 200 crores of gold and other approved securities (such as
dollars, pound sterling, etc.) have to be kept and against this any amount of currency can be
issued depending on the monetary requirements of the economy. RBI is not bound to convert
22
notes into equal value of gold or silver. In the present times currency is inconvertible. The
word written on the note, say 100-rupee notes and signed by the governor of RBI that ‘I
promise to pay the bearer a sum of 100 rupees’ is only a legacy of the past and does not imply
its convertibility into gold or silver. Another important thing to note is that paper currency or
coins are fiat money, which means that currency notes and metallic coins serve as money on
the bases of the fiat (i.e. order) of the Government. In other words, on the authority of the
Government no one can refuse to accept them in payment for the transaction made. That is
why they are called legal tender.
Demand Deposits with the Public:
The other important component of money supply are demand deposits of the public with the
banks. These demand deposits held by the public are also called bank money or deposit
money. Deposits with the banks are broadly divided into two types: demand deposits and
time deposits. Demand deposits in the banks are those deposits which can be withdrawn by
drawing cheques on them. Through cheques these deposits can be transferred to others for
making payments from whom goods and services have been purchased. Thus, cheques make
these demand deposits as a medium of exchange and therefore make them to serve as money.
It may be noted that demand deposits are fiduciary money proper. Fiduciary money is one
which functions as money on the basis of trust of the persons who make payment rather than
on the basis of the authority of Government. Thus, despite the fact that demand deposits and
cheques through which they are operated are not legal tender, they function as money on the
basis of the trust commanded by those who draw cheques on them. They are money as they
are generally acceptable as medium of payment. Bank deposits are created when people
deposit currency with them. But far more important is that banks themselves create deposits
when they give advances to businessmen and others. On the basis of small cash reserves of
currency, they are able to create a much larger amount of demand deposits through a system
called fractional reserve system which will be explained later in detail. In the developed
countries such as USA and Great Britain deposit money accounted for over 80 per cent of the
total money supply, currency being a relatively small part of it. This is because banking
system has greatly developed there and also people have developed banking habits. On the
other hand, in the developing countries banking has not developed sufficiently and also
people have not acquired banking habits and they prefer to make transactions in currency.
However, in India after 50 years of independence and economic development the proportion
of bank deposits in the money supply has risen to about 50 per cent.
Four Measures of Money Supply:

Several definitions of money supply have been given and therefore various measures of
money supply based on them have been estimated. First, different components of money
supply have been distinguished on the basis of the different functions that money performs.
For example, demand deposits, credit card and currency are used by the people primarily as a
medium of exchange for buying goods and services and making other transactions.
Obviously, they are money because they are used as a medium of exchange and are generally
referred to as M1. Another measure of money supply is M 3 which includes both M1 and time
deposits held by the public in the banks. Time deposits are money that people hold as store of
value. The main reason why money supply is classified into various measures on the basis of
its functions is that effective predictions can be made about the likely effects on the economy
of changes in the different components of money supply. For example, if M1 is increasing
firstly it can be reasonably expected that people are planning to make a large number of
transactions. Obviously, they are money because they are used as a medium of exchange and
23
are generally referred to as M1. Another measure of money supply is M3 which includes both
M1 and time deposits held by the public in the banks. Time deposits are money that people
hold as store of value. The main reason why money supply is classified into various measures
on the basis of its functions is that effective predictions can be made about the likely affects
on the economy of changes in the different components of money supply. For example, if M1
is increasing firstly it can be reasonably expected that people are planning to make a large
number of transactions. On the other hand, if time-deposits component of money-supply
measure M3 which serves as a store of value is increasing rapidly, it can be validly concluded
that people are planning to save more and accordingly consume less. Therefore, it is believed
that for monetary analysis and policy formulation, a single measure of money supply is not
only inadequate but may be misleading too. Hence various measures of money supply are
prepared to meet the needs of monetary analysis and policy formulation. Recently in India as
well as in some developed countries, four concepts of money supply have been distinguished.
The definition of money supply given above represents a narrow measure of money supply
and is generally described as M1. From April 1977, the Reserve Bank of India has adopted
four concepts of money supply in its analysis of the quantum of and variations in money
supply. These four concepts of measures of money supply are explained below.
Money Supply M1 or Narrow Money:

This is the narrow measure of money supply and is composed of the following items:
M1 = C + DD + OD
Where C = Currency with the public
DD = Demand deposits with the public in the Commercial and Cooperative Banks.
OD = Other deposits held by the public with Reserve Bank of India.
The money supply is the most liquid measure of money supply as the money included in it
can be easily used as a medium of exchange, that is, as a means of making payments for
transactions.
Currency with the public (C) in the above measure of money supply consists of the
followings:
(i) Notes in circulation.
(ii) Circulation of rupee coins as well as small coins
(iii) Cash reserves on hand with all banks.
Note that in measuring demand deposits with the public in the banks (i.e., DD), inter-bank
deposits, that is, deposits held by a bank in other banks are excluded from this measure.
In the other deposits with Reserve Bank of India (i.e., OD) deposits held by the Central and
State Governments and a few others such as RBI Employees’ Pension and Provident Funds
are excluded.
However, these other deposits of Reserve Bank of India include the following items:
(i) Deposits of Institutions such UTI, IDBI, IFCI, NABARD etc.
24
(ii) Demand deposits of foreign Central Banks and Foreign
Governments. (iii) Demand deposits of IMF and World Bank.
It may be noted that other deposits of Reserve Bank of India constitute a very small
proportion (less than one per cent).
Money Supply M2:

M2 is a broader concept of money supply in India than M1. In addition to the three items of
M1, the concept of money supply M2 includes savings deposits with the post office savings
banks. Thus,
M2 – M1 + Savings deposits with the post office savings banks.
The reason why money supply M2 has been distinguished from M1 is that saving deposits
with post office savings banks are not as liquid as demand deposits with Commercial and
Co-operative Banks as they are not chequable accounts. However, saving deposits with post
offices are more liquid than time deposits with the banks.
Money Supply M3 or Broad Money:
M3 is a broad concept of money supply. In addition to the items of money supply included in
measure M1, in money supply M^ time deposits with the banks are also included. Thus M3 =
M1 + Time Deposits with the banks.
It is generally thought that time deposits serve as store of value and represent savings of the
people and are not liquid as they cannot be withdrawn through drawing cheque on them.
However, since loans from the banks can be easily obtained against these time deposits, they
can be used if found necessary for transaction purposes in this way. Further, they can be
withdrawn at any time by forgoing some interest earned on them.
It may be noted that recently M3 has become a popular measure of money supply. The
working group on monetary reforms under the chairmanship of Late Prof. Sukhamoy
Chakravarty recommended its use for monetary planning of the economy and setting target of
the growth of money supply in terms of M3.
Therefore, recently RBI in its analysis of growth of money supply and its effects on the
economy has shifted to the use of M3 measure of money supply. In the terminology of money
supply employed by the Reserve Bank of India till April 1977, this M3 was called Aggregate
Monetary Resources (AMR).
Money Supply M4:
The measure M4 of money supply includes not only all the items of M3 described above but
also the total deposits with the post office savings organisation. However, this excludes
contributions made by the public to the national saving certificates. Thus, M4 = M3 + Total
Deposits with Post Office Savings Organisation.
The four concepts of money supply as used by Reserve Bank of India in its Monitory
policy
25
OVERALL CONCLUSION OF STUDY OF INDIAN MONETORY POLICY AND
REGULATION OF INDIAN ECONOMY
CONCLUSION: Monetary policy refers to the use of monetary instruments under the control
of the central bank to regulate magnitudes such as interest rates, money supply and
availability of credit with a view to achieving the ultimate objective of economic policy
respectively. partible with each other and, therefore, cannot be achieved simultaneously. With
the changing framework of monetary policy in Indian from monetary targeting to an
augmented multiple indictors approach, the operating targets and processes have also
undergone a change. There has been a shift from quantitative intermediate targets to interest
rates, as the development of financial markets enabled transmission of policy signals through
the interest rate channel. At the same time, availability of multiple instruments such as CRR,
OMO including LAF and MSS has provided necessary flexibility to monetary operations.
While monetary policy formulation is a technical process, it has become more consultative
and participative with the involvement of market participant, academics and experts. The
internal process has also been re-engineered with more technical analysis and market
orientation. In order to enhance transparency in communication the focus has been on
dissemination of information and analysis to the public through the Governor’s monetary
policy statements and also through regular sharing of policy research and macroeconomic and
financial information. All the objectives of monetary policy, i. e., exchange stability, price
stability, full employment, economic growth, etc., are important and have their relative merits
and demerits; None of these objectives is completely undesirable and should be abandoned.
But the problem is that these objectives are not com The Reserve Bank of India had reduced
the repo rate and reverse repo rate to 4.40% and 4.00% on 27 March 2020. However, with
coronavirus pandemic hurting the economy, the central bank has reduced the reverse repo rate
by another 25 basis points on 17 April. Following the reduction, the reverse repo rate stands
at 3.75%. On 27 March 2020, the central bank had reduced the Marginal Standing Facility
(MSF) rate and the bank rate to 4.65%
26
AFFECT OF COVID-19 ON ECONOMIC REFORMS 2020
India’s first wave of economic reforms were triggered by an economic crisis during which
economic growth fell to just 1.1 per cent in 1991. With some estimates suggesting that
India’s economy will contract by a staggering 45 per cent year-on-year contraction for the
current quarter, there are some signs that the current crisis could trigger a change of direction
in terms of economic management – though in which direction is much less clear. Since
Narendra Modi was first elected in 2014 there had been expectations – perhaps more from
external observers than domestic commentators – that he would undertake the ambitious
economic reforms that had eluded his predecessors. In part, the fact that the BJP was the first
party in 30 years to win a majority meant that it would not be held hostage by junior coalition
partners. In addition, Modi was expected to replicate the economic growth he had presided
over as chief minister for Gujarat. His first term did not meet expectations. Some
long-discussed measures, most notably a nationwide tax on goods and services, were
introduced but the grand gesture of demonetization in 2016 – when 80 per cent of India’s
currency was taken out of circulation – caused economic hardship which was still rippling
through the economy when COVID-19, and the subsequent lockdown, hit. Since Modi’s
re-election last year, the government’s agenda shifted further towards a communal agenda as
economic growth slowly fell quarter on quarter. Even before the coronavirus pandemic,
unemployment was thought to stand at a 45-year high. If the pandemic were to lead to
economic reform, there are contradictory signals thus far regarding the likely direction of
change. One recurring theme regarding India’s economy is a widespread belief that
something will happen allowing India to replicate China’s decades of double-digit growth. At
the turn of the century, the idea that India would replicate in services what China did for
manufacturing was widespread. This ignored the fact that India's high-growth services
sectors, such as IT, are capital rather than labour intensive, hence the familiar trope that
India’s demographic dividend would ensure high growth, regardless of skills and training.
The pandemic has spurred the idea that global manufacturing will relocate to India from
China. This seems optimistic. Sure, it might, but long-standing and well-known impediments
to investment in India, such as red tape and infrastructure shortfalls, are likely to mean that
other countries, such as those in Southeast Asia, would benefit first, this notwithstanding that
the pandemic is likely to expedite the pre-existing trend for on-shoring – moving production
closer to markets. Much has been made of Modi’s statement that the pandemic showed the
need for India to be ‘self-reliant’, while stressing that India would not be isolationist or
protectionist. Calls for Indians to prioritise Indian products fit neatly within the general
Hindutva narrative, but beyond that a return to the pre-1991 policy of import substitution
seems both unlikely and, in many sectors, unfeasible. What is more, it would scarcely
encourage foreign firms moving out of China to make India their preferred destination.
Modi's announcement of a major stimulus package provides the greatest reason to expect the
pandemic to trigger more substantive reforms. Notwithstanding that the 10 per cent of GDP
figure appears somewhat creative - some reports have suggested that actual new spending is
around 1 per cent – and putting to one side that most of the focus has been on the supply-side
when India's current problem is a collapse in demand, what the package demonstrates is
India's economic plight. Its ability to raise funding is limited and many of the country’s
citizens – notably day labourers – are ill placed to deal with a prolonged lockdown. Just as in
1991, it may find little choice but to revisit longstanding calls for further reforms such as
labour laws and bureaucratic hurdles. India's labour laws may offer some protection to its
27
formal sector workforce but, as the plight of India's migrant workers showed, they are highly
irrelevant to the majority of the country’s labour force, and the evidence as to whether these
laws deter firms from expansion or investment is mixed. Given the challenges of generating
employment, relaxing labour laws (and applying them universally) might surely be worth
trying. While India has gradually improved in the World Bank's ease of doing business
ranking, there is clearly still room for streamlining investment. In particular, the appearance
that foreign firms do not face a level playing field with domestic competitors will need to be
dealt with if firms leaving China are to make India a preferred destination. For many Indians
though, more important still would be agriculture reform, and the steps taken in the stimulus
package do hint at wider agricultural reform.
CONCLUSION TO MONEY SUPPLY THROUGH INDIAN MONETARY POLICY.

We have seen above how a small increase in reserves of currency with the banks leads to a
multiple expansion in demand deposits by the banks through the process of deposit multiplier
and thus causes growth of money supply in the economy. Deposit multiplier measures how
much increase in demand deposits (or money supply) occurs as a result of a given increase in
cash or currency, reserves with the banks depending on the required cash reserve ratio (r) if
there are no cash drainage from the banking system. But in the real-world drainage of
currency does take place which reduce the extent of expansion of money supply following the
increase in cash reserves with the banks. Therefore, the deposit multiplier exaggerates the
actual increase-in money supply from a given increase in cash reserves with the banks. IN
contrast, money multiplier takes into account these leakages of currency from the banking
system and therefore measures actual increase in money supply when the cash reserves with
the banks increase. The money multiplier can be defined as increase in money supply for
every rupee increase in cash reserves (or high-powered money), drainage of currency having
been taken into account. Therefore, money multiplier is less than the deposit multiplier. It is
worth noting that rapid growth in money supply in India has been due to the increase in
high-powered money H, or what is also called Reserve Money (Lastly Reserve Bank of India,
the money multiplier remaining almost constant. The money supply in a country can be
changed by Reserve Bank of India by undertaking open market operations, changing
minimum required currency reserve-deposit ratio, and by varying the bank rate. The main
source of growth in money supply in India is creation of credit by RBI for Government for
financing its budget deficit and thus creating high-powered money. Further, though the
required currency reserve-deposit ratio of banks can be easily varied by RBI, the actual
currency reserve-deposit ratio cannot be so easily varied as reserves maintained by banks not
only depend on minimum required cash reserve ratio but also on their willingness to hold
excess reserves. Lastly an important noteworthy point is that though money multiplier does
not show much variation in the long run, it can change significantly in the short run causing
large variations in money supply. This unpredictable variation in money multiplier in the
short run affecting money supply in the economy prevents the Central Bank of a country from
controlling exactly and precisely the money supply in the economy
28
BLOGRAPHY
1.
https://www.elibrary.imf.org/view/IMF071/01965-9781557750259/01965-9781557750259
/ch05.xml?language=en&redirect=true
2. https://www.slideshare.net/aarathana/role-of-monetary-policy-in-india 3.
https://www.encyclopedia.com/international/encyclopedias-almanacs-transcripts-and-m
aps/monetary-policy-1991
4. https://sg.inflibnet.ac.in/bitstream/10603/131566/7/07_chapter%201.pdf 5.
https://www.federalreserve.gov/monetarypolicy/files/20200612_mprfullreport.pdf 6.
https://link.springer.com/article/10.1007/s41775-020-00085-3
7. https://www.bankbazaar.com/finance-tools/emi-calculator/monetary-policy.html 29

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MACROECONOMICS PROJECT SEMISTER-III

HARSH VAGAL SYBA-2377

STUDY OF INDIAN MONETORY POLICY AND REGULATION OF

NAME- HARSH VAGAL

ROLL NUMBER- 2377

TIOPIC- STUDY OF INDIAN MONETORY POLICY AND

This is to certify that,

HARSH VAGAL Of Class SYBA-B (2377) have

successfully completed the project Study of STUDY OF

I wish to express our sincere gratitude

INDEX OF THE PROJECT

3 MONETORY POLICY ALSO AFFECTS THE ECONOMY 4

4 BRIEF HISTORY OF INDIAN MONITORY POILICY 5

5 OBJECTIVES OF INIDAN MONITORY POLICY 5

7 TARGETS AND INDICATORS OF INDIAN MONETARY 10

8 ROLE OF INDIAN ECONOMIC POLICY IN INDIA 11

9 FRAMEWORK OF INDIAN MONITORY POLICY. 12

11 INSTRUMENTS OF MONETARY POLICY IN INDIA 14

15 CONCEPTS ACCEPTED BY INDIAN ECONOMY 19

16 THE STANDARD CONCEPT OF MONEY SUPPLY 20

17 FOUR MESURES OF MONEY SUPPLY OF RBI: 21

19 CONCLUSION TO MONEY SUPPLY THROUGH 27

INTRODUCTION TO THE INDIAN MONITORY POLICY

WHY I CHOSE THIS TOPIC? – SIGNIFIANCE OF INDIAN MONETORY POLICY

OBJECTIVES OF INIDAN MONITORY POLICY

INDIAN ECONOMY’S ECONMIC REFORMS (1991 AND 2020)

● Reforms in Capital Markets: Recommendations of the Narasimham Committee were

● In 1991, the government announced a specified list of high technology and

2020 ECONOMIC REFORMS

Targets and Indicators of Indian Monetary Policy

MONITORY TARGETING IN INDIA- OPERATIONG FRAMEWORK 12

ROLE OF INDIAN ECONOMIC POLICY IN INDIA ECONOMY

ROLE OF MONETARY POLICY

2. Creation and Expansion of Financial Institutions:

3. Effective Central Banking:

4. Maintaining Equilibrium in Balance of payments

5.10. Controlling Inflationary

• Developing economies are highly sensitive to inflationary pressures. Large expenditures on

• Debt management is another function of monetary policy in a developing country. Debt

7. Integration of organized and unorganized money market

8. Integrated Interest Rate Structure:

• In an underdeveloped economy, there is absence of an integrated interest rate structure.

FRAMEWORK OF INDIAN MONITORY POLICY.

SCHEMATIC REPRESENTATION OF INDIAN MONITORY FRAMEWORK

Credit authorisation scheme

♣ Repo rate and reverse repo rate

Effectiveness of Monetary Policy in India

The labour markets

THE STANDARD CONCEPT OF MONEY SUPPLY IN INDIAN MONETORY

Currency with the Public:

2. The number of rupee notes and coins in circulation.

3. Small coins in circulation.

Four Measures of Money Supply:

Money Supply M1 or Narrow Money:

OD = Other deposits held by the public with Reserve Bank of India.

(ii) Circulation of rupee coins as well as small coins

(iii) Cash reserves on hand with all banks.

Governments. (iii) Demand deposits of IMF and World Bank.

Money Supply M2:

CONCLUSION TO MONEY SUPPLY THROUGH INDIAN MONETARY POLICY.

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