The Challenges of Monetary Policy Trans[

The Challenges of Monetary Policy Trans[pic 3][pic 4]mission

The challenges and way forward

2 December 2016[pic 5]

Introduction

Definition: Monetary policy decisions taken by RBI propagate through financial markets (e.g. banking system) and directly affect the businesses and households. This influences general economic activities like it may lead to change in consumption or investment because the money supply, inflation and asset prices change.[pic 6]

Figure 1: Monetary policy transmission

MPC: These decisions are now taken by Monetary Policy Committee (MPC) headed by RBI governor Urjit Patel. It was set up by amending the RBI act after the government and RBI agreed to task RBI with responsibility for price stability and inflation targeting. This agreement was signed on February 20, 2015. The first meeting of MPC was held recently in October 2016.

Monetary Policy Transmission Mechanism:[pic 7]

Figure 2: Monetary policy transmission mechanism

RBI announces monetary policies via tools like changing the Repo Rate, Reverse Repo Rate, SLRCLR and OMO. These policies impact interest rates, asset prices, exchange rates, etc. E.g. By setting the interest rate at which financial institutions can borrow short term capital from central bank i.e. repo rate, they can influence money supply & liquidity in the financial system. This in turn influences consumption and investment decisions of individuals and firms, affecting the aggregate demand and finally inflation.

Objectives of Monetary Policy Transmission:

Different countries may have different objectives behind these policy changes depending on their economic conditions and motives. These reasons may range from a single objective of price stability, considered to be the dominant objective in India, to multiple[pic 8] objectives that include growth, employment as well as financial stability. The operating targets of inflation rate, interest rates etc. are just intermediate objectives of monetary policies and their ultimate objectives are as shown in the above figure.

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 Monetary Policy Transmission Channels

The Effectiveness of Monetary Policy -

Exchange Rate Channel:

The foreign exchange market in India has acquired increasing depth with the transition to a market-determined exchange rate system in March 1993 and the subsequent gradual but significant relaxation of restrictions on various external transactions. Exchange rate flexibility, coupled with the gradual removal of capital controls, has widened the scope for monetary maneuverability, enabling transmission through exchange rates.