It may be recalled that real rate of interest is nominal rate of interest minus rate of inflation. conducting monetary policy in an uncertain economic environment using largely untested policy tools.
Raj argued that since investment is an important factor determining economic growth in developing countries, it should be promoted by lowering the interest rates. Growth of these and such other unproductive activities can be held in check by raising the margin requirements for the blackballed collaterals. But to tap and raise savings sufficiently and to prevent its unproductive use, banks and other financial institutions need to be numerous and dispersed throughout the economy in both the urban and rural areas. The profit expectations can be raised by government increasing its expenditure, especially on infrastructural projects which through its multiplier will raise the aggregate demand for goods and services. For example, central banks can purchase Depending on its objectives, monetary policies can be expansionary or contractionary.This is a monetary policy that aims to increase the money supply in the economy by decreasing interest rates, purchasing government securities by central banks, and lowering the reserve requirements for banks.
However, the profit expectations of businessmen depend on the demand for goods produced by the capital assets they plan to invest. (a) Increase in the aggregate rate of savings in the economy; (b) Mobilisation of these savings so that they are made available for the purpose of investment and production; (d) Allocation of investment funds for productive purposes and priority sectors of the economy. When this happens the share prices in India will fall sharply, the Indian rupee would depreciate and thus creating a lot of economic instability in the Indian economy. In the context of the planned development of the underdeveloped countries, the use of methods of selective credit controls and credit rationing is not only necessary but also essential. Subsequently, the banks will increase the interest rate they charge their customers. This happened in 2009-10 when due to the shortage of monsoon rainfall, drop in agricultural production was expected, and inflationary pressures emerged in the Indian economy raising food inflation to around 20 per cent in December 2009.
This will stimulate private investment. Measures such as lengthening the periods of repayment, lowering of margin requirements, providing rediscounting facilities at rates below the bank rate, provision of special loans by commercial banks to be used for specific purposes or the setting up of special investment institutions such as Industrial Development Bank can provide the required inducement to channelise savings in the desired directions. The RBI can reduce the liquidity with the banks by selling government securities to them through open market operations. Monetary policy has to ensure that the banking system contributes to the financing of the planned public investment.
In what follows, we explain the role and limitations of monetary policy in controlling with special reference to India. This can happen when the banks may have surplus liquidity (i.e., cash reserves) with them and therefore they may not follow tight monetary policy and raise their lending rates. Further, to check food inflation, food-grains, pulses, oilseeds and other feed articles in short supply can be imported.
Now in 2007-08 when the prices of houses declined sharply, the people who had got the sub-prime housing loans from the banks started defaulting on paying interest and the principal amount. Monetary policy is important measure for reducing aggregate demand to control inflation. The interest rates were then so low that the conventional monetary policy of lowering interest rates had lost its ability to stimulate the economy. However, tight monetary policy for controlling inflation is not without its limitations. Therefore, to promote investment, the easy monetary policy should be adopted. As Keynes emphasised, it is the prospective yield from investment which plays a crucial role in determining investment. Besides, when industry faces demand recession, public investment is an ideal tool to develop infrastructure and to increase the demand for industrial products through the operation of multiplier.
Since it constitutes a lost opportunity for the commercial banks, central banks pay them interest on the reserves. Monetary policy has an important role to play in boosting up the level of investment by making available savings or resources mobilised by banks for purposes of investment and production. The commercial banking encourages thrift or propensity to save by offering a return on savings in the form of interest rate on bank deposits. A low level of inflation is considered to be healthy for the economy. Monetary Policy Summary i 1 The economic outlook 1 1.1 Recent developments 1 1.2 The MPC’s projections 3 1.3 Key judgements and risks 8 1.4 Constant rate projections 10 Box 1 Negative policy rates 12 Box 2 Monetary policy since the May Report 16 2 Current economic conditions 17 2.1 The global economy 18 2.2 Financial markets and credit conditions 21 2.3 Demand and output 25 2.4 … This can be done by the RBI by raising cash reserve ratio (CRR) and by open market operation through sale of government securities. It reduces liquidity to prevent inflation. Due to large fiscal deficit, aggregate demand was increasing which was feeding inflation in the Indian economy. As it is, the structure of these economies is not very conducive to the general methods of credit control. This will also offset the impact of tight monetary policy of the RBI to control inflation.