Monetary policy is the management of money supply and interest rates by central banks to influence prices and employment. Monetarypolicy works through expansion or contraction of investment and consumption expenditure.Monetary policy is the process by which the government, central bank (RBI in India), or monetary authority of a country controls :
(i) The supply of money
(ii) Availability of money
(iii) Cost of money or rate of interest
In order to attain a set of objectives oriented towards the growth and stability of the economy. Monetary theory provides insight into how to craft optimal monetary policy. Monetary policy is referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy involves raising interest rates in order to combat inflation. Monetary policy is contrasted with fiscal policy, which refers to government borrowing, spending and taxation.Credit policy is not only a policy concerned with changes in the supply of credit but it can be and is much more than this.Credit is not merely a matter of aggregate supply, but becomes more important factor since there is also issue of its allocation among competing users. There are various sources of credit and other aspects of credit that need to be looked into are its cost and other terms and conditions, duration, renewal, risk of default etc. Thus the potential domain of credit policy is very wide. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate in order to achieve policy goals.Monetary policy, also described as money and credit policy, concerns itself with the supply of money as so of credit to the economy.
Objective of monetary policy
The objectives are to maintain price stability and ensure adequateflow of credit to the productive sectors of the economy. Stability ofthe national currency (after looking at prevailing economicconditions), growth in employment and income are also looked into.The monetary policy affects the real sector through long and variable periods while the financial markets are also impacted through shorttermimplications. Major objectives can be summarized as under:
i) To promote and encourage economic growth in the economy & ensure the economic stability at full employment or potential level of output.It aims to achieve the twin objectives of meeting in full the needs of production and trade, and at the same time moderating the growth of money supply to contain the inflationary pressures in the economy.
ii) Sectorial deployment of Funds. Depending upon the priorities laid down in the plans, the RBI has determined the allocation of funds, as also the interest rates among the different sectors.
There are four main 'channels' which the RBI looks at:
* Quantum channel: money supply and credit (affects real outputand price level through changes in reserves money, moneysupply and credit aggregates). * Interest rate channel.
* Exchange rate channel (linked to the currency).
* Asset price.
Price stability has evolved as the dominant objective of monetary policy for sustaining economic growth and ensuring orderly conditions in the financial markets with increasing openness of the Indian economy... The fundamentalidea is that it is only in a low and stable inflation environment that economic growth can be continued. Monetary policy also aims to be directly supportive of growth by ensuring that the credit requirements of various segments are met adequately through an appropriate...