Monetary policy

• Monetary policy is the process by which

the monetary authority of a country controls
the supply of money, often targeting a rate
of interest to attain a set of objectives oriented
towards the growth and stability of the economy .
• These goals usually include stable prices and low
unemployment Monetary theory provides insight
into how to craft optimal monetary policy.
• Monetary policy is referred to as either being
an expansionary policy, or a contractionary policy.
 Continued
• An expansionary policy increases the total supply of
money in the economy rapidly.
• Contractionary policy decreases the total money
supply, or increases it slowly.
• Expansionary policy is traditionally used to
combat unemployment in a recession by
lowering interest rates , while contractionary policy
involves raising interest rates to combat inflation.
• Monetary policy is contrasted with fiscal policy,
which refers to government borrowing, spending and
taxation
 Objectives
• Objectives of Monetary policy are stated below:
– Maintaining price stability
– Ensuring adequate flow of credit to the productive
sectors of the economy.   
– Maintaining orderly conditions in the financial
markets .
– Thus, monetary policy in India endeavors to maintain
a judicious balance between price stability, economic
growth and financial stability.
 Monetary Base
• Monetary policy can be implemented by changing the
size of the monetary base.
• This directly changes the total amount of money
circulating in the economy.
• A central bank can use open market operations to change
the monetary base.
• The central bank would buy/sell bonds in exchange for
hard currency. When the central bank disburses/collects
this hard currency payment, it alters the amount of
currency in the economy, thus altering the monetary base.
 Reserve requirements

• The monetary authority exerts regulatory control

over banks.
• Monetary policy can be implemented by changing
the proportion of total assets that banks must hold in
reserve with the central bank.
• Banks only maintain a small portion of their assets as
cash available for immediate withdrawal; the rest is
invested in illiquid assets like mortgages and loans.
By changing the proportion of total assets to be held
as liquid cash, the Federal Reserve changes the
availability of loan able funds. This acts as a change
in the money supply.
 Discount window lending
• Discount window lending is where the commercial
banks, and other depository institutions, are able to
borrow reserves from the Central Bank at a discount
rate.
• This rate is usually set below short term market rates
(T-bills). This enables the institutions to vary credit
conditions (i.e., the amount of money they have to
loan out), there by affecting the money supply.
• By affecting the money supply, the monetary policy
can establish ranges for inflation, unemployment,
interest rates ,and economic growth.
 Interest rates

• The contraction of the monetary supply can be

achieved indirectly by increasing the  interest rates.
• Monetary authorities in different nations have
differing levels of control of economy-wide interest
rates
• Raising the interest rate(s) under its control, a
monetary authority can contract the money supply,
because higher interest rates encourage savings and
discourage borrowing. Both of these effects reduce
the size of the money supply.
 Open Market Operations
• OMOs involve buying (outright or temporary) and
selling of government securities by the central bank,
from or to the public and banks.
• RBI when purchases securities, pays the amount of
money by crediting the reserve deposit account of
the seller’s bank, which in turn credits the seller’s
deposit account in that bank.
 Growth
•  IMF revised upwards its forecast for global growth
for 2010 from 4.6 per cent to 4.8 per cent.
• The growth process remains uneven being driven
largely by emerging and developing countries.
• The recovery continues to be fragile in the advanced
countries.
 Continued
•  Taking into account the good performance of the
agriculture sector, and a range of indicators of
industrial production and service sector activity , real
GDP growth for 2010-11, is retained at 8.5 per cent.
 Monetary Measures
•  The Bank Rate has been retained at 6.0 per cent. 
• Increase in the repo rate under the liquidity
adjustment facility (LAF) from 6.0 per cent to 6.25
per cent with immediate effect.
• Increase the reverse repo rate under the LAF by 25
basis points from 5 per cent to 5.25 per cent with
immediate effect.
 Monetary Measures
• The cash reserve ratio (CRR) of scheduled banks has
been retained at 6.0 per cent of their net demand
and time liabilities (NDTL).
•  The Reserve Bank has deregulated interest rates on
deposits, other than savings bank deposits. The
interest rate on savings bank deposits has remained
unchanged at 3.5 per cent per annum.
• Non-food credit growth did accelerate from 17.1% in
March 2010 to 22.3 % as on July 2, 2010
 Industrial Growth

• Industrial growth has been robust, Index of industrial

production (IIP) increased with an average 10.6 per
cent.
• Industrial growth was high in the capital goods,
consumer durables and intermediate goods sectors.
• Exports have grown steadily , showing an increase of
27.6 per cent over the corresponding period of last
year.
 Inflation
• On the inflation front, the new series of wholesale
price index (WPI) with an updated base (2004-
05=100).
• Primary food inflation moderated from 21.4 per cent
in May 2010 to 15.7 per cent in September 2010.
• Inflation rate reported has been 9.82%.