What is Monetary Policy and Its Objective ?
Monetary Policy –
Monetary policy is concerned with the measures taken to regulate the supply of money, the cost and availability of credit in the economy. It also deals with the distribution of credit between uses and users and also with both the lending and borrowing rates of interest of the banks.
In the developed economies, it is used to overcome depression and inflation as an anti cyclical policy.
But in the developing countries, it is used to accelerate economic growth, contain inflation and to ensure stability of exchange rate of the currency.
Objectives of Monetary Policy –
1. Price Stability –
Every economic policy has a main objective. Monetary policy is better suited to achieve price stability or to contain inflation.
To quote C. Rangarajan, a former governor of RBI, ‘Faced with multiple objectives that are equally relevant and desirable, there is always the problem of assigning to each instrument (or policy) the most appropriate target or objective. Of the many objectives, price stability is perhaps the one that can be achieved most effectively by monetary policy.’
Achieving price stability has remained the main objective of monetary policy of RBI. Price stability does not mean absolutely no change in price at all, some changes in relative price do occur. A certain rate of inflation is inevitable in the developing economies. So, the price stability means a reasonable rate of inflation.
A high degree of inflation has adverse effects on the economy in many ways, such as –
Firstly, inflation raises the cost of living of the people and sends many people below the poverty line and hurts the poor people most.
Secondly, inflation makes exports expansive, which discourages exports and also encourages imports which adversely effects the balance of payments.
Thirdly, when due to the higher rate of inflation value of money rapidly falling, people do not have much incentive to save. This lowers the rate of saving, which in turn lowers investment and economic growth.
Fourthly, a high level of inflation rate encourages businessmen to invest in unproductive assets such as gold, real estate etc.
An expert committee headed by Prof. S. Chakravarty suggested 4 percent (per annum) rate of inflation as a reasonable rate of inflation which should not be exceed.
2. Economic Growth –
Promoting economic growth is also an important objective of the monetary policy. Monetary policy can promote economic growth by providing adequate credit at a lower cost. There are mainly two types of credit requirements of businesses, First, they have to finance their requirements of working capital. Second, they need credit for finance projects for building fixed capital. Easy availability of credit at low interest rates increases investment and promotes economic growth.
3. Exchange Rate Stability –