Monetary policy


is the management of a nation’s money supply to achieve economic goals by a central bank or currency board. Monetary policy objectives can include control of inflation, control of exchange rates, or even simply economic stability. Monetary policy is contrasted with fiscal policy, which aims to achieve economic goals through taxation and government expenditure. The Federal Reserve, or Fed, handles monetary policy in the United States. The Fed controls the money supply through open market operations, and also sets interest rates between banks and reserve requirements. Tight monetary policy, also called concretionary monetary policy, tends to curb inflation by contracting the money supply. Easy monetary policy, also called expansionary monetary policy, tends to encourage growth by expanding the money supply. Monetary policy: is the process by which the government, central bank, or monetary authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest, in order to attain a set of objectives oriented towards the growth and stability of the economy.[1] Monetary theory provides insight into how to craft optimal monetary policy. Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates in order to combat inflation. Monetary policy should be contrasted with fiscal policy, which refers to government borrowing, spending and taxation. RBI measures: The RBI adopted a number of measures that stopped the rupee's slide and actually led to some appreciation. These measures included an increase in banks' cash reserve ratio and an increase in the RBI's bank rate. Once the rupee had stabilized, the RBI announced a two-phase rollback of the bank rate to 10 percent, and of the CRR to 10 percent. In both cases, the first phase was to be effective from late March and the second in early April. The interest rate on shortterm domestic deposits was also deregulated and banks were allowed to set different prime lending rates.

the natural role of monetary policy in the economy is to maintain price stability. given that monetary policy can affect real activity in the shorter term. Article 105 (1). Monetary policy can affect real activity only in the shorter term (see the transmission mechanism). although monetary policy can help stabilize short-term economic activity. and there are definite limitations to what policy can do. even if they do respond promptly. the Eurosystem will also "support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community". This is laid down in the Treaty establishing the European Community. Formulating monetary policy is a difficult task. These include a "high level of employment" and "sustainable and non-inflationary growth". The Treaty makes clear that ensuring price stability is the most important contribution that monetary policy can make to achieve a favourable economic environment and a high level of employment. shifts in the public’s demand for money may partly offset changes in the money supply. there are “slippages” in the financial mechanism. in the actual implementation of monetary policy decisions aimed at maintaining price stability. Real economic stability requires not only wise monetary policy. The Treaty provisions also imply that. back to top Limitations. More fundamentally. These Treaty provisions reflect the broad consensus that the benefits of price stability are substantial (see benefits of price stability). depository institutions may not always promptly react in response to policy changes. It can be difficult to coordinate the three areas to achieve perfect economic stability.Objective of monetary policy To maintain price stability is the primary objective of the Eurosystem and of the single monetary policy for which it is responsible. In particular. . Under the best conditions. the ECB typically should avoid generating excessive fluctuations in output and employment if this is in line with the pursuit of its primary objective. it cannot affect real variables. Both kinds of slippage complicate the task of the money authorities. such as employment and output in the long run. In addition. "Without prejudice to the objective of price stability". there would be limitations on what monetary policy could do. The Treaty establishes a clear hierarchy of objectives for the Eurosystem. but also sound fiscal policy (the government’s use of taxing and spending to stabilize the economy) and sufficient competition in the economy. It assigns overriding importance to price stability. For example. But ultimately it can only influence the price level in the economy. Maintaining stable prices on a sustained basis is a crucial pre-condition for increasing economic welfare and the growth potential of an economy . the Eurosystem should also take into account the broader economic goals of the Community. But even if fiscal policy was always perfectly prudent and the economy was sufficiently competitive.

Sign up to vote on this title
UsefulNot useful