impact of monetary policy on indian economy in the post-reform period

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Unusual conditions leading up to the business cycle <strong>of</strong> 1989-93, made it difficult to recognize inflationary pressures. Several industrial countries pursued expansionary policies that caused their economies to overheat; <strong>policy</strong> corrections then led to asset-price deflation and severe recessions. Valuable lessons can be drawn from this experience (Garry Schinasi, 1995) (10) . The most important question is whether future business cycles, in a liberalized global financial environment, are likely to have a similar pr<strong>of</strong>ile. Uncertainty about this issue reinforces the need for <strong>monetary</strong> <strong>policy</strong> to remain flexible in the future and for the development <strong>of</strong> more reliable tools for monitoring cyclical developments – including tools making it possible to assess asset- market conditions with greater accuracy. Assessment <strong>of</strong> the money multiplier in the context <strong>of</strong> <strong>monetary</strong> control is given primary importance in the paper, Money Multiplier and Monetary Control, published in October 1995 (Nuran Gokbudak, 1995) (11) . Thus, the objective <strong>of</strong> this paper is to discuss the significance <strong>of</strong> the money multiplier and the <strong>monetary</strong> aggregate in terms <strong>of</strong> <strong>monetary</strong> control and to determine the reasons behind their variation. The importance <strong>of</strong> the money multiplier in terms <strong>of</strong> <strong>monetary</strong> <strong>policy</strong> is analyzed and along with the calculation <strong>of</strong> the money multipliers (k1 and k2), and their parameters, the components <strong>of</strong> Central Bank Money (CBM), which has been used as <strong>monetary</strong> aggregate, and their relative contributions are analyzed. The absolute and relative contributions <strong>of</strong> its components to a change in money supply (M2) are investigated by the author. This paper aims at revealing the importance <strong>of</strong> the control <strong>of</strong> both the <strong>monetary</strong> aggregate and the money multiplier in achieving the targeted level <strong>of</strong> money supply. This, in turn, will enable the Central Bank to provide price stability and high powered money is found to be the major contributor to the change in M2. Sinha (1995) (12), remarks that it is very urgent to keep the finance sector in sound health. This calls for great vigilance on the part <strong>of</strong> the regulatory authorities- the RBI, SEBI and the Central Government. The rate <strong>of</strong> <strong>monetary</strong> expansion should be brought down drastically. That is the real test <strong>of</strong> success <strong>of</strong> central banking <strong>policy</strong>. For all this, we need a truly independent central bank, whose most important quality must be to be able to say ‗No‘ to excessive credit demand, be it from Government or the 11
commercial sector. Otherwise, inflation will become worse, contrary to the complacency one observes in this regard, on the part <strong>of</strong> Government and the RBI. Monetary <strong>policy</strong> has now moved to the center stage <strong>of</strong> economic <strong>policy</strong> making, commends Rangarajan, (1996) (13) while delivering a lecture on ‗Some Issues on Monetary Policy‘, conducted by the ASCI. In fact, many writers feel that inflation is endemic in the process <strong>of</strong> economic growth and inflation is treated more as a consequence <strong>of</strong> structural imbalance than as a <strong>monetary</strong> phenomenon, he remarked. The issue <strong>of</strong> objective has become important because <strong>of</strong> the need to provide clear guidance to <strong>monetary</strong> <strong>policy</strong> makers. The finance minister has described his move to replace ad hoc treasury bills with ways and means advances as a ―bold and radical change‖ which will ―strengthen fiscal discipline‖ and provide ―greater autonomy to the RBI in the conduct <strong>of</strong> <strong>monetary</strong> <strong>policy</strong>‖. EPW Research Foundation (1997) (14) has some commends on it. According to them, it is time the RBI takes a fresh look at various instruments it has deployed or seeks to deploy which have an inherent tendency to prevent the banking and financial system from rendering their traditional role. They quote Nicholas Kaldor‘s words: ―Bank credit should expand at the right rate, neither more nor less. This is neither ensured nor prevented by attempts to control the vagaries <strong>of</strong> the money supply‖. The <strong>monetary</strong>-<strong>policy</strong> environment over the past decade in industrial countries has been increasingly characterized by low and stable inflation and <strong>of</strong>ten large movements in the prices <strong>of</strong> equities, bonds and foreign exchange, or financial assets more broadly. While volatility in part reflects the nature <strong>of</strong> asset prices, driven primarily by revisions in expectations <strong>of</strong> future returns, large movements raise questions about the appropriate response <strong>of</strong> <strong>monetary</strong> <strong>policy</strong>. In the past years, for instance, several central banks have expressed concern about such changes. In many formerly high yielding bond markets such as in Italy and Spain, yields fell by several percentage points, <strong>of</strong>ten putting pressure on the respective central banks to relax <strong>policy</strong> rates (Frank Smets, 1997) (15) . The case <strong>of</strong> price stability as the objective <strong>of</strong> <strong>monetary</strong> <strong>policy</strong> rests on the fact that volatility in prices creates uncertainty in decision making. Rising prices affect 12
Page 1 and 2: IMPACT OF MONETARY POLICY ON INDIAN
Page 3 and 4: DECLARATION I declare that the thes
Page 5 and 6: Palayam, Centre for Development Stu
Page 7 and 8: 2.2.2. Contemporary Monetary Theory
Page 9 and 10: VI. MONETARY POLICY IN INDIA 268 6.
Page 11 and 12: Table No Title VI.18. Gross Domesti
Page 13 and 14: CHAPTER - I INTRODUCTION
Page 15 and 16: Money markets facilitate the conduc
Page 17 and 18: 2. To examine the effectiveness <st
Page 19 and 20: The last chapter provides the summa
Page 21 and 22: For sustaining the high growth path
Page 23: an instrument to generate additiona
Page 27 and 28: Ranjanendra Narayan Nag and Mallina
Page 29 and 30: the allowed objective of</s
Page 31 and 32: the foreign exchange market is at b
Page 33 and 34: Banking and stock market systems ar
Page 35 and 36: conduct of <strong
Page 37 and 38: Monetary policy is
Page 39 and 40: is a systematic response in the Res
Page 41 and 42: anking system. Monetary pol
Page 43 and 44: References 1. Reserve Bank
Page 45 and 46: 28. Manohar Rao, 2000. ‗Fiscal De
Page 47 and 48: 53. Shankar Acharya, 2002. ‗Macro
Page 49 and 50: CHAPTER -II MONETARY THEORY AND POL
Page 51 and 52: money. (4) Johnson (1969) distingui
Page 53 and 54: and liabilities increase by the sam
Page 55 and 56: money helps in equalizing the margi
Page 57 and 58: 5. As a means to capital formation
Page 59 and 60: 3. Interest rate ceiling was freed
Page 61 and 62: To conclude, the role of</s
Page 63 and 64: 2.1.7. Money Market in India The mo
Page 65 and 66: The 182-day Treasury bill was repla
Page 67 and 68: phased in such a manner that existi
Page 69 and 70: market, including issues comprising
Page 71 and 72: 2.1.9. The Financial Sector Reforms
Page 73 and 74: also the characteristic of<
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established demand-and supply analy
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The value of money
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level will be strictly proportional
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deposits (D) of a
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The money supply (M) consists <stro
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employment, rate of</strong
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A. Total Wealth The total wealth is
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Income Friedman‘s quantity theory
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―An irregular simple empirical re
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Finally, even if there is the ‗li
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this model as world occur in a syst
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initial endowments of</stro
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economists believe that like transa
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Thus, the total demand for money ca
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Income; where with the increase in
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interest rate falls. People will, t
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employment is liable to fluctuate.
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atios among financial assets in the
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But, defined in a narrow sense, <st
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(2) Economic growth (3) Full employ
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monetary p
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Full Employment and Economic Growth
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price stability along with distribu
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This new set of fa
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Market yield on Equity Tobin sugges
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interest rate will rise again and s
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thriftiness, could not, it was argu
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Keynes emphasized that the liabilit
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close and regular relationship betw
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8. Friedman, M. 1970. The Counter R
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40. Friedman, Milton. 1956. The qua
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CHAPTER-III SIGNIFICANCE OF MONETAR
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3.1. ROLE OF MONETARY POLICY IN DEV
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most of investment
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many financial assets each differin
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composite or integrated system. Thi
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Despite the general support and ind
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is not just second best; it may eve
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3.3. SOME MONETARY CONSTRAINTS Ther
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countries. There is little reason t
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to monetary <stron
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ultimate goal variables on the othe
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CHAPTER- IV REVIEW OF MONETARY POLI
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currency reserves to $6.4 billion a
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public action. The balance
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4.4. MONETARY POLICY 1994-95 The ye
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of growth
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control money growth. The cash rese
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With regard to industrial productio
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atio of 1.7 per ce
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was restored with the sentiment imp
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eserves by over US $ 2.4 billion du
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government administrative departmen
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1999-2000 and an increase o
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has been significant deceleration i
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and SDR) reached a record level <st
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contribution of in
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cent in June, 2003. Lending rates h
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money as of that d
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from late 2003, posed considerable
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under pressure to reach 7.71 per ce
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Inflation, with its roots in supply
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The increasing trend in gross domes
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The average growth of</stro
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and 9.7 per cent in 2007-08 and 200
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facilitating monetary</stro
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world, for the better part
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went up from around 8 per cent to 1
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This is only a brief report <strong
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CHAPTER - V MONEY MARKET INSTRUMENT
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During 1961-85, the interest rates
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Table: V.1 Lending Rate during the
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ii) In the context of</stro
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iv) The Reserve Bank advised that t
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2004-05 2005-06 There was no releva
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1992-93 i) Deposit interest rates w
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domestic term deposit with a maturi
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(B) deposits. This would apply in r
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paying the depositors at the contra
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ii) Entities other than authorized
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iii) The interest rate ceiling on F
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Facility) served as a transitional
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were provided CLF and ACLF for the
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2. In the case of
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5.4. CALL MONEY MARKET The call mon
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1998-99 i) To develop an efficient
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Bank, an increased access over the
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ii) With effect from the fortnight
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5.5. CERTIFICATE OF DEPOSITS (CDS)
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ii) With a view to provide flexibil
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tend to raise amidst ample liquidit
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iii) In November 1996, the extent <
Page 259 and 260:
as reflected in the close co-moveme
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iii) Effective from November 2, 199
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over the monthly average level <str
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1996-97 PSCFC scheme was terminated
Page 267 and 268:
1999-2000 i) The general refinance
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1992-93 Some of th
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ii) As a measure to boost exports,
Page 273 and 274:
2003-2004 i) The interest rate ceil
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1993-94 i) To provide flexibility t
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2000-01 i) In order to impart great
Page 279 and 280:
viii) A fully functional RTGS syste
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led to improvement in liquidity man
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market and more or less stable inte
Page 285 and 286:
CHAPTER -VI MONETARY POLICY IN INDI
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last resort‘, the central bank he
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November 1951 and increases in the
Page 291 and 292:
the Bank Rate by 1 percentage point
Page 293 and 294:
well as prime Lending Rate. Thus, a
Page 295 and 296:
However, the method of</str
Page 297 and 298:
the 14 th day of t
Page 299 and 300:
1998 - 99 The CRR to be maintained,
Page 301 and 302:
With a view to provide further flex
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2004-05 i) Cash reserve ratio (CRR)
Page 305 and 306:
v) The CRR was proposed (October 6,
Page 307 and 308:
Table VI.2(Contd.) Year Effective s
Page 309 and 310:
percentage of thei
Page 311 and 312:
September 1990. In view of<
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2004-07 2007-08 correspondent banks
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The Section 24 of
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3) To stabilize the securities mark
Page 319 and 320:
Table: VI.4 Reforms in the Governme
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Table: VI.4. (Contd.) Reforms in th
Page 323 and 324:
• Negotiated Dealing System (NDS)
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debt manager the RBI is merely sell
Page 327 and 328:
anks and PDs, these policy<
Page 329 and 330:
automatically invested and can rema
Page 331 and 332:
1992-93 During the year, an active
Page 333 and 334:
1999-2000 i) The Reserve Bank annou
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ii) It was decided that the facilit
Page 337 and 338:
ii) The repo rate under the LAF was
Page 339 and 340:
Year Effective since Table VI.5 Mov
Page 341 and 342:
During the year 1992-93, an active
Page 343 and 344:
Reserve Bank announced liquidity su
Page 345 and 346:
2007-08 i) Withdrawal of</s
Page 347 and 348:
Year Effective Date Table VI.6 (Con
Page 349 and 350:
money against securities. Banks do
Page 351 and 352:
According to Chandler, ―in many c
Page 353 and 354:
(3) Though the banks ensure that lo
Page 355 and 356:
term interest rate as their <strong
Page 357 and 358:
the Central Government. The supply
Page 359 and 360:
Chart VI.3. Annual Percentage Varia
Page 361 and 362:
Annual Variation (%) Chart VI.4. An
Page 363 and 364:
Table: VI.9 Money Multiplier during
Page 365 and 366:
Over a period of t
Page 367 and 368:
1977, the RBI has adopted four alte
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(4) M3 Time deposits or fixed depos
Page 371 and 372:
Year Table VI.10 Net Bank Credit to
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Table: VI.11 Total Bank Credit to C
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Table: VI.12 Net Foreign Exchange A
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liabilities to the public had only
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Reserve money and Narrow Money exhi
Page 381 and 382:
supply in India, in almost all the
Page 383 and 384:
Output can be measured both in nomi
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een facing a loss of</stron
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decade of reform,
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India has still a balance between o
Page 391 and 392:
Let us suppose that velocity is con
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Table VI.21 provides the annual rat
Page 395 and 396:
India‘s inflation can also be mea
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taking both the absolute value and
Page 399 and 400:
of other factors s
Page 401 and 402:
6.2.7. MONETARY POLICY AND ECONOMIC
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Table: VI.27 Credit- Deposit Ratio
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with other advanced and emerging ma
Page 407 and 408:
during 1996, 1998 and 2000-02 were
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Table: VI.31 Net Domestic Capital F
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was at the highest in 1991-92, with
Page 413 and 414:
December 2002, employment growth in
Page 415 and 416:
arising from the slowdown in growth
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to the system by the end of
Page 419 and 420:
17. Reserve Bank of</strong
Page 421 and 422:
CHAPTER-VII SUMMARY, FINDINGS, CONC
Page 423 and 424:
6. It is objective and in discrimin
Page 425 and 426:
Most central banks have, therefore,
Page 427 and 428:
Monetarists believe that the econom
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targets is not enough. Such achieve
Page 431 and 432:
3. In India, the opening up <strong
Page 433 and 434:
18. Given the random nature <strong
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BIBLIOGRAPHY
Page 437 and 438:
Chowdhry, Vikram. 2002. Monetary Po
Page 439 and 440:
Keynes, J.M. 1923. A Tract on Monet
Page 441 and 442:
Van Caspel, Venita. 1988. Money Dyn
Page 443 and 444:
EPW Research Foundation, 2000. ‗S
Page 445 and 446:
Kannan, R., Indranil Sen Gupta and
Page 447 and 448:
Prasanth, V.P. and Shetty, S.A. 200
Page 449 and 450:
Smets, F. 1995. ‗Central Bank Mac
Page 451 and 452:
Kannan, R. ‗The Dimensions <stron
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