Relevance: GS-2: Government policies and interventions for development in various sectors

Relevance: GS-3: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Key phrases: Monetary Policy Committee, Accommodative Stance, Instruments of Monetary Policy, Broad-based recovery, Excess liquidity, Inflationary Pressure, reverse repo.

Why in News?

• Amid growing pressure to increase policy rates to control inflation, the Reserve Bank of India (RBI) Governor has said monetary policy is an art of managing expectations and central banks have to make continual efforts to shape and anchor market expectations.

Context:

• "Monetary policy is not merely a science where we tweak some instrument to achieve an objective. It is also an art of creating new instruments and taking policy calls in response to anticipated and evolving challenges and communicating them with prescience and clarity, especially during crisis times," the RBI Governor said while addressing an event at the National Defence College, Ministry of Defence, in the national capital.
• Indian economic recovery from pandemic needs continued support, said RBI governor Shaktikanta Das, according to the recently released minutes of monetary policy committee.
• The RBI, in its latest monetary policy meeting has kept key policy rates, including repo and reverse repo rates, unchanged for tenth consecutive time in a row even amid other central banks withdrawing emergency support two years after the coronavirus outbreak caused widespread economic stress.
• Das said there was growing uncertainty regarding the evolving global macroeconomic outlook.
• The trajectories of growth and inflation, however, continue to diverge between countries. This has impelled some central banks to embark on aggressive policy tightening to quell inflation risks, while a few others, mostly emerging market economies (EMEs), continue to maintain accommodative policies. The adverse spillovers from such divergent policy responses could materialise quickly on the global and domestic outlook. Policy making is getting increasingly complex in this environment, Shaktikanta Das said.
• On the inflation front, Shaktikanta Das said renewed international crude oil prices need monitoring. "We need to remain watchful of the risks to domestic inflation arising from in international commodity prices due to exogenous factors including geo-political developments."

Why monetary policy is an art of managing expectations?

It is manage the expectation of the economy in term of stability, growth and investment. These are pursued through ensuring credit availability with stability in the external value of rupee and overall financial stability. It manage expectation by following way:

• To Regulate Money Supply in the Economy: Money supply includes both money in circulation and credit creation by banks. Monetary policy is farmed to regulate the money supply in the economy by credit expansion or credit contraction. By credit expansion (giving more loans), the money supply can be expanded. By credit contraction (giving less loans) money supply can be decreased.
• To Attain Price Stability: Another major objective of monetary policy in India is to maintain price stability in the country. It implies Control over inflation. Price level, is affected by money supply. Monetary policy regulates money supply to maintain price stability.
• To promote Economic Growth: An important objective of monetary policy is to make available necessary supply of money and credit for the economic growth of the country. Those sectors which are quite significant for the economic growth are provided with adequate availability of credit.
• To Promote saving and Investment: By regulating the rate of interest and checking inflation, monetary policy promotes saving and investment. Higher rates of interest promote saving and investment.
• To Control Business Cycles: Boom and depression are the main phases of business cycle. Monetary policy puts a check on boom and depression. In period of boom, credit is contracted, so as to reduce money supply and thus check inflation. In period of depression, credit is expanded, so as to increase money supply and thus promote aggregate demand in the economy.
• To Promote Exports and Substitute Imports: By providing concessional loans to export oriented and import substitution units, monetary policy encourages such industries and thus help to improve the position of balance of payments.
• To ensure more Credit for Priority Sector: Monetary policy aims at providing more funds to priority sector by lowering interest rates for these sectors. Priority sector includes agriculture, small- scale industry, weaker sections of society, etc.
• To Promote Employment: By providing concessional loans to productive sectors, small and medium entrepreneurs, special loan schemes for unemployed youth, monetary policy promotes employment.
• To Develop Infrastructure: Monetary policy aims at developing infrastructure. It provides concessional funds for developing infrastructure.
• To Regulate and Expand Banking: RBI regulates the banking system of the economy. RBI has expanded banking to all parts of the country. Through monetary policy, RBI issues directives to different banks for setting up rural branches for promoting agricultural credit. Besides it, government has also set up cooperative banks and regional rural banks. All this has expanded banking in all parts of the country.

Instruments of Monetary Policy

There are several direct and indirect instruments that are used for implementing monetary policy. The instruments of monetary policy are of two types:

• Quantitative, general or indirect (CRR, SLR, Open Market Operations, Bank Rate, Repo Rate, Reverse Repo Rate).
• Qualitative, selective or direct (change in the margin money, direct action, moral suasion).
• These both methods affect the level of aggregate demand through the supply of money, cost of money and availability of credit. Of the two types of instruments, the first category includes bank rate variations, open market operations and changing reserve requirements (cash reserve ratio, statutory reserve ratio).
• Policy instruments are meant to regulate the overall level of credit in the economy through commercial banks. The selective credit controls aim at controlling specific types of credit. They include changing margin requirements and regulation of consumer credit.

Way forward:

• The primary objective of monetary policy is to maintain price stability while keeping in mind the objective of growth. Price stability is a necessary pre-condition to sustainable growth.
• The conduct of monetary policy has undergone notable changes in India and across the world as economies and markets evolved and policymakers gained greater insights into how economic agents interact in a complex economic system.
• As monetary policy is an art of managing expectations, central banks have to make continual efforts to shape and anchor market expectations, not just through pronouncements and actions but also through a constant refinement of their communication strategies to ensure the desired societal outcomes.
• The communication works both ways - while too much communication can confuse the market, too little may keep it guessing about the central bank’s policy intent.
• The central bank also recognise that communication needs to be backed by commensurate actions to build credibility and instil wider confidence in policies.

Source: Live Mint

Mains Question:

Q. “The monetary policy played a vital role in the economic development of India by minimizing fluctuations in prices and general economic activity”. Critically analyse the Statement.