Instruments

Monetary Policy means the policy by which the government of a country and the central bank try to control the supply of the money and the availability of credit in the system , with a view to achieve economic stability.

There are two instruments of monetary policy:-

  1. Quantitative instruments
  2. Qualitative instruments

Objectives of Monetary Policy

The objectives of a monetary policy in India are similar to the objectives of its five year plans. In a nutshell planning in India aims at growth, stability and social justice. After the Keynesian revolution in economics, many people accepted significance of monetary policy in attaining following objectives.

Let us now see objectives of monetary policy in detail :-

  1. Rapid Economic Growth: It is the most important objective of a monetary policy. The monetary policy can influence economic growth by controlling real interest rate and their resultant impact on investment. If the RBI opts for a cheap or easy credit policy by reducing interest rates, the investment level in the economy can be This increased investment can speed up economic growth. Faster economic growth is possible if the monetary policy succeeds in maintaining income and price stability.
  2. Price Stability: All economics suffer from inflation and deflation. It can also be called Price Instability. Inflation is harmful to the economy. Thus, the monetary policy has the objective of price stability and tries to keep the value of money stable. It helps in reducing income and wealth inequalities. When the economy suffers from recession the monetary policy should be an 'easy money policy' but when there is an inflationary situation there should be a dear money policy.
  3. Exchange Rate Stability: The exchange rate is the price of a home currency expressed in terms of any foreign currency. If this exchange rate is very volatile leading to frequent ups and downs in the exchange rate, the international community might lose confidence in our monetary policy aims at maintaining the relative stability in the exchange rate. The RBI by altering the foreign exchange reserves tries to influence the demand for foreign exchange and tries to maintain the exchange rate stability.
  4. Balance of Payments (BOP) Equilibrium: Many developing countries like India suffer from Disequilibrium in the BOP. The Reserve Bank of India through its monetary policy tries to maintain equilibrium in the balance of payments. The BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. The former reflects an excess money supply in the domestic economy, while the latter stands for the stringency of money. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP equilibrium can be achieved.
  5. Full Employment: It refers to the absence of involuntary unemployment. In simple words 'Full Employment' stands for a situation in which everybody who wants jobs get jobs. However, it does not mean that there is Zero unemployment. In that sense, full employment is never a Monetary policy that can be used for achieving full employment. If the monetary policy is expansionary then credit supply can be encouraged. It could help in creating more jobs in different sector of the economy.
  6. Neutrality of Money: Economist such as Wicksted, Robertson have always considered money as a passive factor. According to them, money should play only a role of medium of exchange and not more than that. Therefore, the monetary policy should regulate the supply of money. The change in money supply creates monetary disequilibrium. Thus monetary policy has to regulate the supply of money and neutralize the effect of money expansion. However, this objective of a monetary policy is always criticized on the ground that if money supply is kept constant then it would be difficult to attain price stability.
  7. Equal Income Distribution: Many economists used to justify the role of the fiscal policy is maintaining economic equality. However in resent years economists have given the opinion that the monetary policy can help and play a supplementary role in attainting an economic monetary policy can make special provisions for the neglect supply such as agriculture, small-scale industries, village industries, etc. and provide them with cheaper credit for longer term. This can prove fruitful for these sectors to come up. Thus in recent period, monetary policy can help in reducing economic inequalities among different sections of society.

Limitations of Monetary policy

  1. Lack of cooperation by commercial banks
  2. Unorganized sector
  3. Lack of banking habits of people
  4. Problem in forecasting of Inflation and deflation
  5. Time lag