Monetary Policy Instrument in India

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CHAPTER 1
MONETARY POLICY INSTRUMENTS- AN INTRODUCTION

Money plays a dominant role in the life of human society. It has fashioned and shaped the destiny and fortunes of kings and rulers. With the rise of the philosophy of laissez faire and capitalism, money became a motivating force and fuel to all economic activities throughout the world.

Money and its management were not unknown to the ancient India. Kautilaya had devoted a part of his famous ‘Arthasastra’ on money and minting. Even the Vedic and ‘Pauranic’ scriptures have revealed the use and importance of money during those days.

The powerful forces behind the process of transition of economy from a barter, semi-feudal system to a modern monetized sector are the use of money proper. We have embarked on the path of planned economic development with the advent of the five year plans in the countries in fifties. We have adopted the mixed economy in which both public sector and private sector go hand in hand but wedded to the ultimate goal of “socialist pattern of society”.

Monetary policy in any country is largely conditioned by the institutional framework and environment in which it is expected to operate the structure of money market is the base on which the operation of monetary policy will depend. Monetary management is largely governed by institutional factors like the use of credit, credit consciousness of the people and their preferences, the general banking structure and development of banking habits of the people as a whole.

Monetary policy is the name given to the principles whereby the Government and the Central Bank of a country fulfill the general objectives of the country’s economic policy. Thus, monetary policy has no objective of its own and is at best a handmaid of general economic policy.

In recent years, almost all the countries of the world have been suffering from the malady of inflation. It has become a world wide phenomenon. Developing economies have suffered the most as most of the people in these countries are living below poverty line. Indian economy is no exception to it. The Indian economy has been experiencing the strange phenomenon of steep rise in prices in certain sectors of the economy coupled with stagnation in certain sectors of the economy. This is known as ‘stagflation’.

This study reflects that with the changing economic scenario, efforts have been made for re-designing the monetary policy which can sub serve the needs of our planned economy. The monetary policy in our country is functioning in traditional style. Even in the western countries, the techniques of central banking have undergone major changes. The monetary policy has been functioning under heavy stress and strains. It should be moulded according to the socio-economic needs of our planned economy.

Among country-specific studies on monetary policy frameworks, a study on India would be important. This is not only because of the large size of its population or economy, but because a few specific features make India a unique case study among countries. Although India consistently maintained a democratic form of governance, prior to the 1990s its economic framework was largely similar to that of a command and control economy. During the past 20 years or so, the Indian economy has oriented itself towards market forces, with a healthy rate of GDP growth and a modest rate of inflation. This change had been gradual and except for the balance of payments crisis during 1990-91, has come with minor hiccups. Given that this period is characterized by frequent financial crises in large parts of the world, the Indian experience and the role played by the monetary framework in it can be a valuable lesson in preventing financial crises, and also in pacing and sequencing economic reforms.

Monetary policy rests on the relationship between the rates of interest in an...
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