Monetary Policy

What is Monetary Policy?

• It is a macroeconomic policy tool used by the Central Bank to influence the money supply in the economy to achieve certain macroeconomic goals.
• Objectives:
  • Accelerating the growth of the economy.
  • Maintaining price stability.
  • Generating employment.
  • Stabilizing the exchange rate.

Monetary Policy vs Fiscal Policy

Types of Monetary Policy

Expansionary Monetary Policy

• It is also called Accommodative Monetary Policy.
• Its primary aim is to increase the money supply in the economy and fuel economic growth by stimulating business activities and consumer spending and also helps to lower unemployment rates.
• Steps taken as per this policy are-
  • Decreasing interest rates – It makes it less expensive for consumers to borrow money, thus increasing the money supply in the market.
  • Lowering reserve requirements for banks – It leaves commercial banks with more money to lend to the public, thus infusing more money into the economy.
  • Purchasing government securities by central banks – The RBI buys government securities by paying cash. This means that money available in the market increases.

Contractionary Monetary Policy

• It is used to decrease the amount of money supply to reduce inflation.
• Steps taken as per this policy-
  • Raising interest rates – It makes it more expensive for consumers to borrow money, thus reducing the money supply in the market.
  • Increasing the reserve requirements for banks – It leaves commercial banks with less money to lend to the public, thus reducing the money supply in the economy.
  • Selling government bonds – The buyers of government securities pay cash to the RBI. This means that money available in the market decreases.