It is stated in the Preamble of the Reserve Bank of India Act 1934 that, the primary goal of the monetary policy is to maintain price stability while keeping in mind the objective of growth. “Goals of Monetary Policy” is one of the important concepts in the UPSC/IAS 2023 Economy syllabus which is discussed in this article in detail.

What is Monetary Policy?

• Monetary policy refers to a collection of activities that a country's central bank can take to control the entire money supply and achieve long-term economic growth.
• Monetary policy can be broadly categorised into - Expansionary or contractionary monetary policy.
• Interest rates can be raised or lowered, cash can be directly lent to banks, and bank reserve requirements can be changed.

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Goals of Monetary Policy

• The primary goal of monetary policy is to maintain price stability while still pursuing the goal of economic growth. Price stability is a critical prerequisite for long-term growth.
• The Reserve Bank of India (RBI) Act, 1934 was revised in May 2016 to give a legal basis for the flexible inflation targeting framework's implementation.
• The amended RBI Act also mandates that the government of India, in collaboration with the Reserve Bank, determine the inflation target once every five years.
• As a result, the Central Government published a notice in the Official Gazette setting a target of 4% Consumer Price Index (CPI) inflation for the period August 5, 2016 to March 31, 2021, with a 6% upper tolerance limit and a 2% lower tolerance limit.
• The Central Government retained the inflation target and tolerance band for the following 5-year period – April 1, 2021 to March 31, 2026 – on March 31, 2021.
• The following issues have been identified by the central government as contributing to the inability to meet the inflation target:
  1. For any three consecutive quarters, average inflation exceeds the inflation target's upper tolerance level; or
  2. For any three consecutive quarters, average inflation falls below the lower tolerance level.
• Prior to the May 2016 change to the RBI Act, the flexible inflation targeting framework was controlled by a February 20, 2015 Monetary Policy Framework Agreement between the Government and the Reserve Bank of India.

Other Goals of Monetary Policy

• Promotion of saving and investment: A higher rate of interest means more opportunities for investment and savings, ensuring a healthy cash flow in the economy.
• Managing business cycles: A business cycle has two primary stages: boom and depression. By regulating credit to manage the availability of money, monetary policy is the most effective weapon for controlling the boom and bust of business cycles.
• Controlling imports and exports: Monetary policy assists export-oriented units in substituting imports and increasing exports by assisting them in obtaining a loan at a lower interest rate. As a result, the state of the balance of payments improves.
• Aggregate demand regulation: When credit is expanded and interest rates are lowered, more people are able to get loans for the purchase of goods and services.
• Employment Generation: Small and medium companies (SMEs) can readily obtain a loan for business expansion because to the monetary policy's ability to cut interest rates. This could result in more job chances.
• Helping infrastructure development: The monetary policy allows for concessional funding for infrastructure development within the country.

Tools to achieve the goals of Monetary Policy

• The Reserve Bank of India in its Bi-monthly Monetary Policy Review meeting changes the monetary policy tools according to the prevailing inflation and economic situation.
• For instance, due to the COVID-19 situation present in the country in March 2020, the RBI took an accommodative stance and reduced Repo Rate by 75 basis points from 5.15% to 4.40%.
  • It also reduced reverse repo rate from 4.9% to 4.00% and Marginal Standing Facility rate from 5.40% to 4.65% to boost consumption.
• Some important tools are:
  • Liquidity Adjustment Facility
    • Repo Rate
    • Reverse Repo Rate
  • Marginal Standing Facility Rate (MSF) or Bank Rate
  • Cash Reserve Ratio (CRR)
  • Statutory Liquidity Ratio (SLR)

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Conclusion

The Reserve Bank of India has successfully maintained its primary goal of inflation targeting in the first five years of the statutory agreement with the government by altering the instruments of monetary policy accordingly.