Monetary Policy and Its Major Objectives

Monetary Policy

Monetary Policy is the process through which monetary authority of a country controls the supply of money and liquidity in the economy by exercising its control over interest rates. Monetary authority is normally the central bank. In the case of India, it is Reserve Bank of India. RBI through monetary policy tries to achieve economic objectives like low and stable inflation, price stability and high economic growth by controlling the cost and availability of money supply in the economy. Monetary policy techniques are also called credit control techniques as monetary policy influences the lending policy of banks and thereby flow of credit. 

Expansionary and contractionary monetary policies

Monetary policy that tries to increase total supply of money at a rapid pace is known as expansionary. In a contractionary policy, the money supply expands at a slow pace than usual or even shrinks. 

Methods of monetary controls (Credit control techniques)

Lending policy of banks affects the cost of the credit and the easiest way for a central bank to adjust liquidity is by influencing the lending policy of banks. RBI, for instance changes the policy with the following objectives:

i.    Stabilize the price level

Frequent changes in price level adversely affect economy and RBI controls credit to prevent inflationary or deflationary trends. The primary objective of monetary policy itself is achieving price stability with low and stable inflation. 

ii.    Stabilize foreign exchange rate and maintain Balance of Payment (BoP) 

Change in the domestic price level affects the exports and imports of a country. When prices fall, domestic sale becomes less profitable and exports increase and imports decline. Consequently, the demand for domestic currency in the foreign market increases and its exchange rate rises. The reverse happens with rise in domestic prices. As the volume of credit affects prices, the RBI can stabilize the rate of foreign exchange by controlling bank credit. 

Expansion in bank credit increases domestic price levels, reduces exports and increases imports. This has a negative impact on the forex reserve of the country. Hence, the RBI uses monetary policy tools to maintain stability of Balance of Payment (BoP) position. 

iii.    To control business cycles and business needs

Business cycles affect supply of products, employment and prices. The central bank counter attacks such cyclical fluctuations by contraction of bank credit during boom periods and expansion of bank credit during depression. By ensuring proper availability of credit, the RBI meets the requirements of trade and business  
and controls business activities and employment opportunities. 

iv.    Ensure growth with stability

The objectives of credit policy have undergone changes and as of now ensuring growth with price stability has emerged as the major objective. The monetary policy now focuses on achieving accelerated growth with price stability in economy.  This objective in fact affects all other objectives as this aim has direct bearing on inflationary pressures, balance of payment position and employment.