Bombay Stock Exchange

Monetary policy is the use by the Government or central bank ( In Indian Context RBI) of interest rates or controls on the money supply to influence the Economy. The reserve bank of India is the agency which formulates and Implements monetary policy on behalf of the Indian government in an attempt to achieve a set of objectives that are expressed in terms of macroeconomic variables such as the achievement of a desired level or rate of growth in real activity, the exchange rate, the price level or inflation, the balance of payment, real output and employment. Monetary policy works through the effects of the cost and availability of loans on real activity, and through this on inflation, and on international capital movements and thus on the exchange rate. Its actions such as changes in the RBI discount rate have at best an indirect effect on macroeconomic variables and considerable lags are involved in the policy transmission Mechanism. Monetary policy makes use of various Instruments which include interest rate, reserve requirements (cash requirements or cash ratio and liquidity ratio), selective credit controls, rediscount rate, Treasury bill rate amongst others.
Electronic copy available at: http://ssrn.com/abstract=1743834

When the RBI wants to implement a contractionary monetary policy, it goes to the security market to sell government bonds for money thus decreasing the money stock or the money in circulation in the economy. Contractionary policy is used to combat inflation. Furthermore, monetary policies are described as follows: Accommodative, if the interest rate set by the central monetary authority is intended to create economic growth; Neutral, if it is intended neither to create growth nor combat inflation; or Tight if it is intended to reduce inflation. Having understood the meaning and types of monetary policy, it becomes expedient to give an explanation of stock markets for better understanding of stock markets’ behaviour and their reaction to