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Managerial Economics - Monetary Policy

Introduction, Objectives and Limitations of Monetary Policy

   Posted On :  29.05.2018 11:47 pm

Monetary policy is an important economic tool which is used to attain many macroeconomic goals.

Introduction, Objectives and Limitations of Monetary Policy

Introduction


Monetary policy is an important economic tool which is used to attain many macroeconomic goals. Monetary policy regulates the supply of money and availability of credit in the economy. It deals with both the lending and borrowing rates of interest of commercial banks. It aims to maintain price stability, full employment and economic growth. Reserve Bank of India (RBI) is responsible for formulating and implementing monetary policy of India. It was announced twice a year (slack season and busy season) but now once in a year. It refers to the credit control measures adopted by the central bank of a country.
                                                                              
The efforts of monetary authorities to increase the benefits of existing monetary system and to reduce the disabilities in the process of economic development and growth can be called the monetary policy of the country.

Objectives Of Monetary Policy Of India:

 
1.      To achieve Price stability
 
2.      To attain Exchange rate stability
 
3.      To avoid the negative impacts of business cycle
 
4.      To experience full employment position
 
 
Instruments: The major instruments used to achieve the above said objectives are
 
Bank rate: The rate of interest charged by the RBI against the commercial bank borrowings. If RBI increases the bank rate from 2% to 3% then the commercial banks rate of interests will go up from for example 7% to 10% which in turn reduce the public borrowings due to higher interests and minimize the money circulation in the country.
 
Reserve ratio: CRR (Cash Reserve Ratio), SLR (statutory Liquidity Ratio) the RBI insist on commercial banks to keep a certain percentage as reserve in their hands for ensuring liquidity and regulating credit. The RBI can increase the CRR from 3% to 15%. In case when the RBI increases CRR from 10% to 12% then the availability of money in the hands of banks will come down. Thus the credit creating capacity of the commercial banks will be reduced and money supply in the market also will be regulated.
 
Open market operation: RBI selling the government securities to the public. In that case instead of having money in the hands the public will receive certificates for a fixed time period and they will receive interest against the same. But the money circulation among the public will be reduced.
 
Margin requirements: Margin requirement for mortgaging against the loans will be increased to reduce to credit and it will be reduced to increase the credit flow.
 
Credit rationing: The loans and advances are provided only for production purpose and for essential activities to cut down the money in circulation.
 
Moral suasion: RBI controls the commercial banks for creating loans and advances by persuasion through issue of circular.
 
Direct actions: Sometimes RBI takes direct action against the credit created by the banks in contravention of the RBI guide line to overcome the inflationary situation.
 

Limitations Of Monetary Policy:


1.      Monetary policy operates in a broad front
 
2.      Success and failure depends on the banking system of the country
 
3.      It has Institutional restrictions
 
4.      Unorganized money market does not support the monetary policy
 
5.      Existence of non monetized sector also defies RBI’s regulation
 
6.      It is not very effective in overcoming depression.

 

Tags : Managerial Economics - Monetary Policy
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