DAYANANDA SAGAR COLLEGE OF ENGINEERING

Shavige Malleshwara Hills, Kumaraswamy Layout, Bengaluru-560078

An Autonomous Institute Affiliated to VTU, Belagavi

THE DEPARTMENT OF MANAGEMENT STUDIES

Subject: ECONOMICS & POLICY FOR

MANAGERS
Sub Code: 22MBA17
Faculty Name: Dr. Mary Metilda J

A Report on Monetary Policy

Submission Date: 02/04/2024

Team: Shashidhar Reddy
Shamanth Adiga
Sampath Chinchewadi Bhimappa
Shivani Shanbhogue Y
Shivani Chandrashekar Surkod
Shashi Kiran K

Faculty Remark: _____________________________________

Faculty Signature: _____________________________________

PROGRAM OUTCOME PROGRAM EDUCATIONAL

OBJECTIVES
1. Management Knowledge
PEO1: Graduates will have the
required knowledge of
2. Decision Making
3. Leadership

DEPARTMENT OF MANAGEMENT STUDIES

VISION STATEMENT
To be a contemporary Business School of National repute

MISSION STATEMENT
M1: To provide a quality environment for developing functional, analytical, and critical thinking abilities to enhance
employability

M2: To create an environment that enhances cognitive skills and teamwork for the holistic development

M3: To inculcate ethics, values, and social sensitivity toward sustainable business practices

M4: To ignite, create, and nurture entrepreneurship for the benefit of business and society

DAYANANDA SAGAR COLLEGE OF

ENGINEERING
(An Autonomous Institute Affiliated to VTU, Approved by AICTE & ISO 9001:2015 Certified)

Team: Shashidhar Reddy

Shamanth Adiga
Sampath Chinchewadi Bhimappa
Shivani Shanbhogue Y
Shivani Chandrashekar Surkod
Shashi Kiran K

DATE OF SUBMISSION: 02/04/2024

SIGNATURE OF THE FACULTY:

Contents
1. Introduction to Monetary Policy
a. Definition and purpose
b. Role in shaping the economic landscape

2. Types of Monetary Policy

a. Expansionary monetary policy
 b. Contractionary monetary policy
c. When and why, each is used

3. Monetary Policy Process in India

a. Monetary Policy Framework Agreement
b. Objectives of the framework
c. RBI's role in determining policy interest rates
d. Biannual reports and inflation targeting

4. Monetary Policy Updates

a. Latest updates (e.g., repo rate, GDP growth forecast, inflation forecast)
b. Open market operations (OMO) and liquidity management

5. Composition of Monetary Policy Committee (MPC)

a. Formation and structure
b. Roles and responsibilities of MPC members
c. Decision-making process

6. Tools of Monetary Policy

a. Statutory Liquidity Ratio (SLR)
b. Cash Reserve Ratio (CRR)
c. Open Market Operations
d. Bank Rate (Discount Rate)

1.0 Introduction to Monetary Policy

Monetary policy is the process by which the monetary authority of a country, generally the
central bank controls the supply of money in the economy. In India, the central monetary
authority is the Reserve Bank of India (RBI)

The Monetary Policy Committee (MPC) in India is responsible for setting the country's
benchmark interest rate. The committee convenes at least quarterly, and it releases its
decisions publicly after each meeting. The MPC consists of six members: three from the
Reserve Bank of India and three external members appointed by the government. The
governor of the Reserve Bank of India leads the committee and has the deciding vote in the
event of a tie.

Before and after each meeting, members must observe a "silent period" lasting seven days to
maintain confidentiality. The committee aims to keep annual inflation around 4% until March
31, 2026, with a tolerance range of 2% to 6%.

The MPC was established through amendments to the Reserve Bank of India Act in 2016,
enhancing transparency and accountability in India's monetary policy formulation. After each
meeting, the committee releases its monetary policy decisions, along with each member's
opinions. If inflation stays outside the prescribed range for three consecutive quarters, the
committee must report to the government of India.

1.2 Role in shaping the economic landscape

The primary objective of monetary policy is to maintain price stability while keeping in mind
the objective of growth. Price stability is a necessary precondition for sustainable growth. To
maintain price stability, inflation needs to be controlled.

Inflation: Contractionary monetary policy is used to temper inflation and reduce the level of
money circulating in the economy. Expansionary monetary policy fosters inflationary
pressure and increases the amount of money in circulation. The government of India sets an
inflation target for every five years. RBI has an important role in the consultation process
regarding inflation targeting. The current inflation targeting framework in India is flexible.

Unemployment: An expansionary monetary policy decreases unemployment as a higher

money supply and attractive interest rates stimulate business activities and expansion of the
job market.

Exchange Rates: The exchange rates between domestic and foreign currencies can be
affected by monetary policy. With an increase in the money supply, the domestic currency
becomes cheaper than its foreign exchange.

2.0 Types of Monetary Policy.

Monetary policy can be broadly categorized into two main types based on their goals:

1. Expansionary Monetary Policy.

 2. Contractionary Monetary Policy.
2.1 Expansionary Monetary Policy.
Expansionary monetary policy, also known as loose monetary policy, aims to
stimulate economic growth by increasing the money supply in circulation within the
economy. This is typically implemented during periods of slow economic growth or
recession. Here's a deeper dive into its workings:

Goals of Expansionary Monetary Policy:

 Boost Economic Growth: By increasing the money supply, the cost of borrowing
becomes cheaper, encouraging individuals and businesses to spend and invest more.
This increased spending leads to higher demand for goods and services, ultimately
driving economic growth.
 Reduce Unemployment: As businesses invest and expand due to cheaper borrowing,
they create more job opportunities, leading to a decrease in unemployment.
 Combat Deflation: When economic activity slows down significantly, it can lead to
deflation, where prices fall over time. Expansionary policy helps prevent deflation by
increasing the money supply, which can stabilize or slightly increase prices.

Tools Used in Expansionary Monetary Policy:

 Decreasing Interest Rates: Central banks like the Federal Reserve can lower their
benchmark interest rate, which influences all other interest rates in the economy.
This makes borrowing cheaper for consumers (mortgages, car loans) and businesses
(loans for expansion).
 Lowering Reserve Requirements: Banks are required to hold a certain percentage of
their deposits as reserves. By lowering this requirement, the central bank allows
banks to lend out more money, further increasing the money supply.
 Open Market Operations: Central banks can directly purchase government bonds
from investors. This injects money into the financial system as the sellers receive
cash for the bonds. This increases the money supply and lowers interest rates further.

Effects of Expansionary Monetary Policy:

 Increased Economic Activity: As borrowing becomes cheaper, consumer spending

and business investment rise, leading to overall economic growth.
  Potential Inflation: While stimulating growth, an excessive increase in the money
supply can lead to inflation, where prices rise over time. This can become a concern
if not managed carefully.
 Currency Devaluation: Increased money supply can sometimes lead to a decrease in
the value of the domestic currency compared to foreign currencies.
2.2 Contractionary Monetary Policy.
Contractionary monetary policy, also known as tight monetary policy, aims to slow
down economic growth by decreasing the money supply in circulation within the
economy. This is primarily used to combat inflation, which is a sustained increase in
the price of goods and services. Here's a breakdown:

Goals of Contractionary Monetary Policy:

 Control Inflation: When the economy experiences excessive growth, prices can rise
rapidly, eroding the purchasing power of money. Contractionary policy aims to curb
inflation by reducing the money supply, making it less readily available for spending
and investment.
 Prevent Asset Bubbles: When excessive money supply fuels rapid price increases in
assets like stocks or real estate, it can create unsustainable bubbles. Contractionary
policy helps prevent such bubbles by tightening the money supply.
 Maintain Price Stability: Central banks often target a specific inflation rate to
maintain long-term economic stability. Contractionary policy helps achieve this
target by moderating inflation when it rises above the desired level.

Tools Used in Contractionary Monetary Policy:

 Raising Interest Rates: Central banks can increase their benchmark interest rate,
which influences all other interest rates in the economy. This makes borrowing more
expensive for consumers (mortgages, car loans) and businesses (loans for
expansion), leading to decreased spending and investment.
 Increasing Reserve Requirements: Banks are required to hold a certain percentage of
their deposits as reserves. By increasing this requirement, the central bank limits the
amount of money banks can lend out, effectively reducing the money supply.
 Selling Government Bonds: Central banks can sell government bonds to investors.
This absorbs money from the financial system as investors pay for the bonds. This
reduces the money supply and pushes interest rates higher.
Effects of Contractionary Monetary Policy:

 Reduced Economic Growth: As borrowing becomes more expensive, consumer

spending and business investment decrease, leading to slower economic growth.
 Controlled Inflation: By reducing the money supply, inflation is brought under
control, preventing prices from rising excessively.
 Potential for Recession: If implemented too aggressively, contractionary policy can
lead to a recession, characterized by significant economic decline and
unemployment.

2.3 When and Why each is used

Central banks utilize different types of monetary policy based on the current economic
situation and desired outcome:

When Expansionary Monetary Policy is Used:

 Economic Slowdown or Recession: When economic growth stalls or a recession

occurs, characterized by a decline in economic activity and rising unemployment,
expansionary policy is implemented. By increasing the money supply and
lowering interest rates, the goal is to stimulate borrowing, spending, and
investment, ultimately leading to economic recovery.
 Deflation: Deflation, a sustained decrease in the price level, can harm the
economy as it discourages spending and investment. Expansionary policy helps
prevent deflation by increasing the money supply and encouraging economic
activity.

When Contractionary Monetary Policy is Used:

 Inflation: When the economy experiences excessive growth, leading to a

sustained rise in the price of goods and services (inflation), contractionary policy
is used to slow down the economy. By reducing the money supply and raising
interest rates, the goal is to curb inflation and prevent it from becoming
uncontrollable.
 Asset Bubbles: Unsustainable increases in asset prices like stocks or real estate
can create bubbles that eventually burst, causing significant economic damage.
Contractionary policy helps prevent such bubbles by tightening the money supply
and slowing down excessive financial speculation.
 Additional Considerations:

 Central banks usually employ a combination of tools: They rarely rely solely on
one tool like interest rates but often combine them to achieve the desired effect.
 Monetary policy has a delayed effect: Changes in monetary policy take time to
fully impact the economy, requiring careful monitoring and adjustments as
needed.
 Balancing Act: Central banks must strike a delicate balance between stimulating
growth and controlling inflation. Overly aggressive expansionary policy can lead
to excessive inflation, while overly restrictive contractionary policy can trigger a
recession.

Therefore, the type of monetary policy used depends on the specific economic
challenges a country face. Central banks constantly analyse economic data and adjust
their policies to maintain a stable and healthy economic environment.

3.0 Introduction to Monetary Process in India:

The Monetary Policy Framework Agreement between the Government and RBI sets the
objectives, including an inflation target, for conducting monetary policy. The RBI determines
key policy interest rates to manage liquidity, inflation and credit conditions, with the primary
goal of achieving price stability. Through biannual reports, the RBI explains its policy stance
and progress towards meeting the inflation target.

The Monetary Policy Framework Agreement (MPFA):

In 2015, a pivotal agreement was established between the Government of India and the
Reserve Bank of India (RBI). The MPFA serves as a cornerstone document, outlining the
objectives and institutional framework for conducting monetary policy in India. This
framework provides a clear roadmap for the RBI, ensuring effective and transparent
management of the nation's economic well-being.

Objectives of the framework:

The MPFA prioritizes two critical, yet sometimes competing, objectives:

 Price Stability (Low Inflation): Maintaining stable prices is paramount for a healthy
economy. High inflation, where prices rise rapidly, erodes purchasing power and
 disrupts economic planning. The MPFA emphasizes keeping inflation under control,
analogous to a car traveling at a steady, predictable speed.
 Economic Growth: A growing economy fosters job creation and improves living
standards. The framework acknowledges the importance of fostering economic
expansion, akin to pressing the accelerator to move forward.

The RBI's challenge lies in achieving a delicate balance between these two objectives. The
MPFA ensures accountability, holding the RBI responsible for maintaining this crucial
equilibrium.

RBI's role in determining policy interest rates:

Similar to how a car's gears influence its movement, the RBI utilizes key policy rates to
regulate the Indian economy. The most crucial of these is the repo rate, the rate at which
banks borrow money from the RBI. By strategically adjusting these rates, the RBI can
influence the amount of money circulating in the system:

 Lowering Rates to Stimulate Growth: If the economy requires a boost, similar to

needing to climb a hill, the RBI might lower the repo rate. This makes borrowing
cheaper for banks, encouraging them to lend more to businesses and individuals. This
increased money flow can stimulate economic activity.
 Raising Rates to Combat Inflation: Conversely, if inflation rises excessively (like
the car accelerating out of control), the RBI might raise the repo rate. This
discourages excessive borrowing and spending, helping to bring down inflation.
Imagine this as shifting to a higher gear to slow down the car.

Biannual reports and inflation targeting:

The MPFA mandates transparency and accountability from the RBI. Biannual reports are
published, detailing the RBI's assessment of the economic landscape and their planned course
of action for monetary policy. This transparency, akin to checking the rear view mirror while
driving, allows the public to understand the rationale behind the RBI's decisions.
Furthermore, the agreement establishes an inflation target, a specific range within which the
RBI aims to maintain inflation. This target functions as a set speed limit, providing a clear
benchmark for the RBI's actions.

5.0 Composition of Monetary Policy Committee (MPC)

The Monetary Policy Committee (MPC) is a key decision-making body within a central bank
responsible for formulating and implementing monetary policy. Here's an overview of its
formation, structure, roles, responsibilities of members, and the decision-making process:

Formation and Structure:

The MPC is typically established by legislation or regulatory authority within a country's

central bank.

It usually consists of a group of experts in economics, finance, and related fields, both from
within the central bank and external members appointed by the government or central bank.

The number of members can vary but is often between 5 to 9, including the central bank
governor who often chairs the committee.

Roles and Responsibilities of MPC Members:

The primary responsibility of MPC members is to set the monetary policy stance of the
central bank.

Members analyze economic data, financial market developments, and other relevant
information to assess the current state of the economy.

They deliberate on whether monetary policy needs to be tightened, loosened, or maintained at

its current level to achieve the central bank's objectives, typically including price stability
and/or full employment.

MPC members communicate their views on the economy and monetary policy through public
statements, speeches, and meeting minutes.

Decision-making Process:
MPC meetings are typically held at regular intervals, such as monthly or quarterly, although
extraordinary meetings may be called in response to significant economic events.

At these meetings, members review economic indicators, such as inflation, employment,

GDP growth, and financial market conditions.

Discussions among MPC members involve assessing the balance of risks to the economy and
the appropriateness of the current monetary policy stance.

The decision-making process usually involves voting on whether to change the central bank's
policy interest rate (e.g., the federal funds rate in the case of the Federal Reserve).

The decision may be made by a simple majority vote, with the central bank governor often
holding a decisive vote in the event of a tie.

After the meeting, the MPC communicates its decision, along with the rationale behind it,
through a public statement or press conference.

Overall, the MPC plays a crucial role in determining the direction of monetary policy, which
in turn influences interest rates, inflation, and economic activity in the country.

6.0 Introduction to Monetary Policy Tools:

Monetary policy tools are like levers that the Reserve Bank of India (RBI) uses to manage the
amount of money flowing into the economy and to control key factors like inflation and
interest rates. These tools help the RBI keep the economy stable and growing.

Cash Reserve Ratio (CRR):

CRR is a portion of the bank's deposits that banks have to keep with the RBI. If the RBI
wants to reduce the amount of money in the banking system, it increases the CRR. This
means banks can lend less, which reduces spending and inflation. If the RBI wants to boost
the economy, it decreases the CRR, allowing banks to lend more.

Statutory Liquidity Ratio (SLR):

SLR is the percentage of deposits banks must invest in safe, liquid assets like government
securities. It ensures that banks have enough assets to cover withdrawals. Changes in SLR
affect how much money banks can lend.
Open Market Operations (OMOs):

OMOs are when the RBI buys or sells government securities in the open market. When the
RBI buys securities, it injects money into the economy, increasing liquidity. Selling securities
does the opposite.

Bank Rate (Discount rate):

The Bank Rate is the rate at which the RBI lends to commercial banks. It influences other
interest rates in the economy. If the RBI raises the Bank Rate, borrowing becomes more
expensive, which can help reduce inflation

In conclusion, the Reserve Bank of India's monetary policy tools, including the CRR, SLR,
OMOs, and Bank Rate, are instrumental in regulating the economy. These tools help manage
liquidity, control inflation, and ensure financial stability. Understanding and effectively using
these tools are crucial for the RBI to achieve its economic objectives and maintain a healthy
economy.