Monetary Policy Transmission in India

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Monetary Policy Transmission Mechanism in India|
Group 6|
Adarsh N (PGP/16/060)
Deepak Jangid(PGP/16/080)
Eshnna V P Ekka(PGP/16/081)
Gaurav Chand(PGP/16/082)
Hemant Kumar(PGP/16/083)
Nishanth S(PGP/16/096)
Adarsh N (PGP/16/060)
Deepak Jangid(PGP/16/080)
Eshnna V P Ekka(PGP/16/081)
Gaurav Chand(PGP/16/082)
Hemant Kumar(PGP/16/083)
Nishanth S(PGP/16/096)
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12/22/2012|

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Abstract
This paper tries to explain the structure of monetary policies in India. Earlier shadowed by fiscal policies, monetary policies have evolved through many stages to gain significant influence over the economy. A major role was played by 1991 transformations which resulted into market forces showing great impact on the economy. A dire need was seen by RBI to make changes in the existing structure of policies. Some changes were followed in 1997-98 and 2004. Introduction of MSS (Market Stabilization Scheme) and FRBM (Fiscal Responsibility and Budget Management), Act allowed monetary policies to gain more autonomy and separation from the fiscal policies. Also, this report makes an effort to examine the transmission mechanism of monetary policy in India. The results lead to the conclusion that the lending rate initially increases in response to a monetary tightening. Bank lending channel play an important role in transmission of monetary policy shocks to the real sector. 1. Introduction

A key characteristic of the efficient transmission of monetary policy is the condition that it must extend a systematic influence on the economy in forward-looking sense. Broadly, vehicles of transmission are classified into financial market prices and financial market quantities.

These channels are not mutually exclusive in their performance, the effectiveness of these channels differ from one country to another country depending upon structural characteristics, state of development of financial markets, the monetary instruments available, the fiscal stance and the degree of openness.

I. Objectives of Monetary Policy
The Reserve Bank of India Act, 1934 sets out the objectives of the Bank: “to regulate the issue of Bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage”. The underlying twin objectives of monetary policy in India are widely regarded as (i) price stability and (ii) provision of adequate credit to productive sectors of the economy so as to support aggregate demand and ensure high and sustained growth. A great amount of synergies have been observed between price stability and financial stability in India.

II. Framework and Instruments
The evolution of framework and instruments has been a long process in India which can be basically divided in three time periods: a) Prior to Mid -1980s
Until this period no formal enunciation of objectives and instruments was mentioned other than administering allocation of and demand for credit.

b) From 1985-1997
During this period Growth in broad money supply (M3) was projected in a manner consistent with expected GDP growth and a tolerable level of inflation. Operating target was : Reserve Money and Operating instrument was Bank Reserves. But market forces picked up influence due to increased liquidity and capital flows resulted through reforms. This led to the increased influence of interest rate on policy transmission

Figure: Until 1997 banks used bank reserves as operating instruments which it ceased to use post 1997-98.

c) Post 1997-98
Policy objectives obtained by the combination of interest rate and other market rates were set in operations. Central objective was high economic growth while inflation targeting was made secondary. Over the time inflation targeting led to the requirement of efficient financial markets and reduction of interdependence of monetary and fiscal policies.

Market Development
Market...
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