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TNPSC Free Notes Economy In English – Monetary Policy

இந்தக் கட்டுரையில், TNPSC குரூப் 1, குரூப் 2, குரூப் 2A, குரூப் 4 மாநிலப் போட்டித் தேர்வுகளான TNUSRB, TRB, TET, TNEB போன்றவற்றுக்கான  முறைகள் இலவசக் குறிப்புகளைப் பெறுவீர்கள்.தேர்வுக்கு தயாராவோர் இங்குள்ள பாடக்குறிப்புகளை படித்து பயன்பெற வாழ்த்துகிறோம்.

Monetary Policy

Monetary Policy
 Monetary Policy is the macroeconomic policy being laid down by the Central Bank
towards the management of money supply and interest rate.
 It is the demand side economic policy used by the Government of a country to achieve
macroeconomic objectives like inflation, consumption, growth and liquidity.
 The monetary policy gained its significance after World War II, thanks to the initiation
made by Milton Friedman, who is associated with the doctrine of “monetarism” and
who received the Nobel Prize in 1976.
 He boldly announced in his book “Monetary History of the United States, 1867 — 1960”
that the Great Depression of the 1930s was largely the outcome of the bungling
monetary policies of the Federal Reserve System.
Monetary Policy: Expansionary Vs. Contractionary
 Expansionary policy is cheap money policy when a monetary authority uses its tools to
stimulate the economy.
 An expansionary policy maintains short-term interest rates at a lower than usual rate or
increases the total supply of money in the economy more rapidly than usual.
 It is traditionally used to try to combat unemployment by lowering interest rates in the
hope that less expensive credit will entice businesses into expanding.
 This increases aggregate demand (the overall demand for all goods and services in an
economy), which boosts short-term growth as measured by gross domestic product
(GDP) growth.
 The contractionary monetary policy is dear money policy, which maintains short-term
interest rates higher than usual or which slows the rate of growth in the money supply
or even shrinks it.
 This slows short-term economic growth and lessens inflation.
 Contractionary monetary policy can lead to increased unemployment and depressed
borrowing and spending by consumers and businesses, which can eventually result in an
economic recession if implemented too vigorously.

Objectives of Monetary Policy
 The monetary policy in developed economies has to serve the function of stabilization
and maintaining proper equilibrium in the economic system.
 But in the case of underdeveloped countries, the monetary policy has to be more
dynamic so as to meet the requirements of an expanding economy by creating suitable
conditions for economic progress.
 It is now widely recognized that monetary policy can be a powerful tool of economic
Neutrality of Money
 Economists like Wicksteed, Hayek and Robertson are the chief exponents of neutral
 They hold the view that monetary authority should aim at the neutrality of money in the
 Monetary changes could be the root cause of all economic fluctuations.
 According to neutralists, the monetary change causes distortion and disturbances in the
proper operation of the economic system of the country.
Exchange Rate Stability
 Exchange rate stability was the traditional objective of the monetary authority. This was
the main objective under Gold Standard among different countries.
 When there was disequilibrium in the balance of payments of the country, it was
automatically corrected by movements.
 It was popularly known as “Expand Currency and Credit when gold is coming in; contract
currency and credit when gold is going out.”
Price Stability
 Economists like Crustave Cassel and Keynes suggested price stabilization as a main
objective of monetary policy.
 Price stability is considered the most genuine objective of monetary policy. Stable prices
repose public confidence. It promotes business activity and ensures the equitable
distribution of income and wealth. As a consequence, there is a general wave of
prosperity and welfare in the community.
 But it is admitted that price stability does not mean ‘price rigidity’ or price stagnation’.
Full Employment

 During world depression, the problem of unemployment had increased rapidly. It was
regarded as socially dangerous, economically wasteful and morally deplorable.
 Thus, full employment was considered as the main goal of monetary policy.
 With the publication of Keynes’ General Theory of Employment, Interest and Money in
1936, the objective of full employment gained full support as the chief objective of
monetary policy.
Economic Growth
 Economic growth is the process whereby the real per capita income of a country
increases over a long period of time.
 It implies an increase in the total physical or real output, production of goods for the
satisfaction of human wants.
 For bringing equality between demand and supply, flexible monetary policy is the best
Equilibrium in the Balance of Payments
 Equilibrium in the balance of payments is another objective of monetary policy which
emerged significantly in the post-war years.
 This is simply due to the problem of international liquidity on account of the growth of
world trade at a faster speed than the world liquidity.
 It was felt that increasing of deficit in the balance of payments reduces the ability of an
economy to achieve other objectives.
 As a result, many less developed countries have to curtail their imports which adversely
affects development activities. Therefore, monetary authority makes efforts to maintain
equilibrium in the balance of payments.

Monetary Policy Committee

About Monetary Policy Committee
 The RBI has constituted the Monetary Policy Committee (MPC) which frames
monetary policy using tools like the repo rate, reverse repo rate, bank rate and
Cash Reserve Ratio (CRR).
 It has been instituted by the Central Government of India under Section 45ZB of
the RBI Act, 1934.

The MPC is given responsibility of deciding the different policy rates including MSF
(Marginal Standing Facility), Repo Rate, Reverse Repo Rate, and Liquidity Adjustment
Composition of the MPC
 The committee will have six members. Of the six members, the Government will
nominate three. Non Government official will be nominated to the MPC.
 3 members will be from RBI. Governor of RBI will act as ex-officio chairperson of
the committee.
Selection and Term of Members:
 Selection
 The Government nominees to the MPC will be selected by a Search-cum-
Selection Committee under the Cabinet Secretary with the RBI Governor and
Economic Affairs Secretary.
 Term
 Members of the MPC will be appointed for a period of four years and shall not
be eligible for reappointment.
 How decisions are made?
 Decisions will be taken by majority vote with each member having a vote.
 The Role of the RBI Governor
 The RBI Governor will chair the Monetary policy committee. The Governor,
however, will not enjoy a veto power to overrule the other panel members
but will have a casting vote in case of a tie.

Methods of Credit Control
I. Quantitative or General Methods:
1. Bank Rate
2. Open Market Operations
3. Variable Cash Reserve Ratio
Bank Rate Policy:
 Bank rate policy is also called as Discount rate policy.
 The rate at which the Central Bank of a country is prepared to re-discount the first-
class securities is called the bank rate.
 It means the bank is prepared to advance loans on approved securities to its member

Open Market Operations:
In narrow sense – The Central Bank starts the purchase and sale of Government
securities in the money market.
In broad Sense – The Central Bank purchases and sells not only Government securities
but also other proper eligible securities like bills and securities of private concerns.
Variable Reserve Ratio:
Cash Reserves Ratio:
 Banks are required to hold a certain proportion of their deposits in the form of cash with
RBI. This is known as CRR.
 Variable Cash Reserve Ratio as an objective of monetary policy.
 It was first suggested by J.M. Keynes.
 It was first followed by Federal Reserve System in United States of America.
 Under this system the Central Bank controls credit by changing the Cash Reserves Ratio.
 For example, if the Commercial Banks have excessive cash reserves on the basis of
which they are creating too much of credit, this will be harmful for the larger interest of
the economy.
 So, it will raise the cash reserve ratio which the Commercial Banks are required to
maintain with the Central Bank.
 Similarly, when the Central Bank desires that the Commercial Banks should increase the
volume of credit to bring about an economic revival in the economy.
 If the CRR is high, the commercial bank’s capacity to create credit will be less and if the
CRR is low, the commercial bank’s capacity to create credit will be high.
Statutory Liquidity Ratio:
 Statutory Liquidity Ratio (SLR) is the amount which a bank has to maintain in the form of
cash, gold or approved securities.
 The quantum is specified as some percentage of the total demand and time liabilities
(i.e., the liabilities of the bank which are payable on demand anytime, and those
liabilities which are accruing in one month’s time due to maturity) of a bank.
II. Qualitative or Selective Method of Credit Control:
 The qualitative or the selective methods are directed towards the diversion of credit
into particular uses or channels in the economy. Their objective is mainly to control and
regulate the flow of credit into particular industries or businesses.
 The following are the frequent methods of credit control under selective method:
 Rationing of Credit

 Direct Action
 Moral Persuasion
 Method of Publicity
 Regulation of Consumer’s Credit
 Regulating the Marginal Requirements on Security Loans
Rationing of Credit
 This is the oldest method of credit control.
 It was first used by the Bank of England by the end of the 18 th Century.
 It aims to control and regulate the purposes for which credit is granted by commercial
 It is generally of two types.
 The variable portfolio ceiling
 The variable capital asset ratio
The variable portfolio ceiling:
It refers to the system by which the central bank fixes ceiling or maximum amount of loans and
advances for every commercial bank.

The variable capital asset ratio:
It refers to the system by which the central bank fixes the ratio which the capital of the
commercial bank should have to the total assets of the bank.
Direct Action
 The central bank may refuse to altogether grant discounting facilities to such banks.
 The central bank may refuse to sanction further financial accommodation to a bank
whose existing borrowing are found to be in excess of its capital and reserves.
 The central bank may start charging penal rate of interest on money borrowed by a
bank beyond the prescribed limit.
Moral Suasion
 This method is frequently adopted by the Central Bank to exercise control over the
Commercial Banks.
 Under this method Central Bank gives advice, requests and persuades the Commercial
Banks to co-operate with the Central Bank in implementing its credit policies.

 Central Bank in order to make their policies successful, take the course of the medium
of publicity.
 A policy can be effectively successful only when an effective public opinion is created in
its favour.
Regulation of Consumer’s Credit
The down payment is raised and the number of installments reduced for the credit sale.
Regulating the Marginal Requirements on Security Loans
 This system is mostly followed in U.S.A.
 Under this system, the Board of Governors of the Federal Reserve System has been
given the power to prescribe margin requirements for the purpose of preventing an
excessive use of credit for stock exchange speculation.
 This system is specially intended to help the Central Bank in controlling the
volume of credit used for speculation in securities under the Securities Exchange
Act, 1934.

Repo Rate (RR)
 The rate at which the RBI is willing to lend to commercial banks is called Repo Rate.
 Whenever banks have any shortage of funds they can borrow from the RBI, against
 As a tool to control inflation, RBI increases the Repo Rate, making it more expensive for
the banks to borrow from the RBI Similarly, the RBI will do the exact opposite in a
deflationary environment.
Reverse Repo Rate (RRR)
 The rate at which the RBI is willing to borrow from the commercial banks is called
reverse repo rate.
 If the RBI increases the reverse repo rate, it means that the RBI is willing to offer
lucrative interest rate to banks to park their money with the RBI.
 This results in a decrease in the amount of money available for banks customers as
banks prefer to park their money with the RBI as it involves higher safety.

 This naturally leads to a higher rate of interest which the banks will demand from their
customers for lending money to them.
 The Repo Rate and the Reverse Repo Rate are the frequently used tools with which the
RBI can control the availability and the supply of money in the economy.
 RR is always greater than RRR in India.


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