OBJECTIVES OF MONETARY POLICY

The Objectives of Monetary Policy

• The objectives set for monetary policy are important because they provide explicit guidance to policy makers. Monetary policy of a country is in fact a reflection of its economic policy and therefore, the objectives of monetary policy generally coincide with the overall objectives of economic policy. 
• There are significant differences among different countries in respect of the selection of objectives, implementation procedures and tools of monetary policy either due to differences in the underlying economies or due to differences in the financial systems and in the infrastructure of financial markets. 
• Coverage of aspects related to monetary policies of different countries would be beyond the scope of this unit. Therefore, the following discussions relate to the monetary policy situations in the context of Indian economy.
• In the pre-Keynesian period, monetary policy, with its conventional objective of establishment and maintenance of stability in prices, was the single well- acknowledged instrument of macroeconomic policy. 
• The Great Depression in 1930s and the associated economic crises marked a turning point resulting in a major shift in the objective of governments’ economic policy in favour of maintenance of full employment, more generally described as economic stability.
•  The most commonly pursued objectives of monetary policy of the central banks across the world are maintenance of price stability (or controlling inflation) and achievement of high level of economy’s growth and maintenance of full employment.
• The Reserve Bank of India Act, 1934, in its preamble sets out the objectives of the Bank as ‘to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage’. 
• It is to be noted that though price stability as an objective is not explicitly spelt out, the monetary policy in India has evolved towards maintaining price stability and ensuring adequate flow of credit to the productive sectors of the economy. Price stability, as we know, is a necessary precondition for sustainable growth. Fundamentally, the primary objective of monetary policy has been maintenance of a judicious balance between price stability and economic growth.
• Multiple objectives, all of which are equally desirable, such as rapid economic growth, debt management, moderate long-term interest rates, exchange rate stability and external balance of payments equilibrium were incorporated as objectives of monetary policy by policy makers in later years. The need for simultaneous achievement of several objectives brings in the possibility of conflict among the different monetary policy objectives.
•  For example, there is often a conflict between the objectives of holding down both inflation and unemployment; a policy targeted at controlling inflation is very likely to generate unemployment. As such, based on the set national priorities, the monetary policymakers have to exercise appropriate trade-offs to balance the conflicting objectives.

Given the development needs of developing countries, the monetary policy of such countries also incorporate explicit objectives such as:

(i) maintenance the economic growth,

(ii) ensuring an adequate flow of credit to the productive sectors,

(iii) sustaining - a moderate structure of interest rates to encourage investments, and

(iv) creation of an efficient market for government securities.

Considerations of financial and exchange rate stability have assumed greater importance in India recently on account of increasing openness of the economy and the progressive economic and financial sector reforms.