What are objectives of monetary policy and Critically examine the effectiveness of the different tools of monetary policy with reference to India
Monetary Policy refers to the Central Bank's programme of changing monetary variables, viz., total supply of money, interest rates and credit rationing, to achieve certain predetermined objectives, one of the primary objectives of monetary policy is to achieve economic stability. The following are the traditional monetary instruments through which a central bank carries out the monetary policies.
Open market operations.
Changes in bank rate (or discount rate), and
Changes in the statutory reserve ratios.
Nature of Monetary Policy
Monetary
Policy has two interpretations. In a broad sense, it refers to all those
monetary and non-monetary measures which influence the cost and supply of money
in a given economy while monetary measures include such weapons as bank rate,
open market operations variable reserves and others non-monetary measures
comprise wage and price controls and budgetary operations. In its narrow sense,
monetary policy refers to the steps taken by a Central bank (Reserve Bank of
India in our country) to regulate the cost and supply of money and credit in
order to achieve certain Socio-economic objectives like price stabilization,
full employment, exchange, regulation and faster economic growth. It is in this
narrow sense that the monetary policy is popularly understood.
Objectives of Monetary Policy:
If the
prices are determinants of internal value of money exchange rate defines the
external value of money. There is a close and inverse relationship between the
domestic price level and the foreign exchange rate of the country's currency.
With rising domestic prices exports fall imports rise and the deficit in
balance of trade increases. This would lead to depreciation of the exchange
value of a currency.
Fluctuating
exchange rates generate a degree of uncertainty in the international exchange
that is not desirable. With fluctuating exchange rate, international trade and
capital flows are adversely affected. Keeping the stability of exchange rates
has been recognized as an important objective of monetary policy.
The world
monetary system today is based on freely floating exchange rates. The preserve
the stability of exchange rates, monetary authorities effectively use the
interest rate mechanism. Differential interest rates between the advanced
countries of the world initiate capital flows which are generally helpful. In
some circumstances, however these international capital flows have destabilizing
influence on the nation's economy.
Monetary
policy has to be used as contra-cyclical tool capitalist economies guided by
free market price mechanism, after experience depression on inflation. By
judiciously using the volume of credit, monetary authorities can counter
cyclical pressures in a nation's economy. Expansion of money supply during
depression and contraction of money supply inflation are effective
contra-cyclical measures.
Full
employment of productive factor, labour and capital, has been regarded as a
prime objective of economic policy. By matching the money demand though money
supply at the level of full employment the monetary authorities can help
achieve and maintain full employment.
Money supply
in the economy, which includes the volume of bank propounded quantity theory of
money according to which, money supply credit, influences the level of prices
in the economy. Irving Fisher the national economy. For the growth of economy,
stability of prices is a on prices is still recognized inflation and deflation
are both injurious to desired objective and this is the prime objective of
monetary policy