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Indian Economic Policy

Notes (viii) Availability of credit instruments : Till 1985-86, the Indian money market did not have
adequate short-term paper instruments. Apart from the call money market, there was only
the treasury bill market. At the same time, there were no specialist dealers and brokers dealing
in different segments of the Indian money market and in different kinds of paper instruments.
20.2 Monetary Policy

Monetary policy, in general, refers to the action taken by the monetary authorities to control and
regulate the demand for and supply of money with a given purpose. Monetary policy is one of the
two most powerful tools of economic control and management of the economy. The various aspects
of monetary policy have been discussed in a theoretical framework in different previous chapters,
especially the effect of different kinds of monetary policies on the aggregate production, interest rate
and the price level. In this section, we will discuss monetary policy in detail. The major aspects of the
monetary policy discussed include :
(i) Meaning and scope of monetary policy;
(ii) Monetary policy instruments and target variables;
(iii) Role of monetary policy in achieving macroeconomic goals;
(iv) Effectiveness and limitations of monetary policy; and
(v) Monetary vs Fiscal policy controversy.
These aspects of monetary policy are discussed in theoretical tone with brief inputs from India’s
monetary policy.
Meaning and Scope of Monetary Policy
The economists have defined monetary policy in different words. For example, Harry Johnson defines
monetary policy as a “policy employing central bank’s control of the supply of money as an instrument of
achieving the objectives of general economic policy.” G. K. Shaw defines monetary policy as “any conscious
action undertaken by the monetary authorities to change the quantity, availability or cost ... of money.”

Monetary policy is essentially a programme of action under-taken by the monetary authorities,
generally the central bank, to control and regulate the supply of money with the public and
the flow of credit with a view to achieving predetermined macroeconomic goals.

The objectives of monetary policy are generally the objectives of macroeconomic policy, viz. growth,
employment, stability of price and foreign exchange, and the balance-of-payment equilibrium. The
macroeconomic goals are determined on the basis of the economic needs of the country. Once
macroeconomic goals are determined, then the monetary authorities will have to decide accordingly
whether to increase or decrease the supply of money. Then the next step is to make the choice of instruments
that can effectively increase or decrease money supply with the public.
Scope of Monetary Policy

The scope of monetary policy spans the entire area of economic transactions involving money and
the macroeconomic variables that monetary authorities can influence and alter by using the monetary
policy instruments. The scope of monetary policy depends, by and large, on two factors :
(i) the level of monetization of the economy, and
(ii) the level of development of the Financial market.
In a fully monetized economy, the scope of monetary policy encompasses the entire economic activities.
In such an economy, all economic transactions are carried out with money as a medium of exchange.
In that case, monetary policy works by changing the supply of and demand for money and the
general price level. It is therefore capable of affecting all economic activities—production, consumption,
savings and investment. The monetary policy can influence all major macro variables—GDP, savings
and investment, employment, the general price level, foreign trade and balance of payments.

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