Y V Reddy: Parameters of Monetary Policy in India
Lecture by Dr Y V Reddy, Deputy Governor of the Reserve Bank of India, at the 88th Annual Conference of The Indian Econometric Society at Madras School of Economics, Chennai, 15 January 2002. Dr Y V Reddy is grateful to Dr D V S Sastry, Shri Deepak Mohanty, Shri Indranil Bhattacharyya and Shri Kaushik Bhattacharya for their assistance
It is a great honour to be asked to deliver an invited lecture at the annual conference of the Indian Econometric Society and I am grateful to the organisers for this opportunity. For obvious reasons, including the growing interest in monetary policy, I intend presenting before you the parameters of monetary policy in India. In the first part of this lecture, I propose to give a general overview of the parameters of monetary policy. In the second part, I would touch upon the international experience in this regard with a particular focus on changing contours. The third part contains a description of evolving parameters of monetary policy in India beginning with a brief description of the process of policy making. The fourth part would highlight the impressive gains made dring the reform period so far, in regard to statutory preemptions, deregulation of interest rates, financial and external stability despite the persisting fiscal deficits and large market borrowing programmes. The concluding part sets forth immediate tasks before the Reserve Bank of India in its conduct of monetary policy.
Parameters of Monetary Policy Objectives It is generally believed that central banks ideally should have a single overwhelming objective of price stability. In practice, however, central banks are responsible for a number of objectives besides price stability, such as currency stability, financial stability, growth in employment and income. The primary objectives of central banks in many cases are legally and institutionally defined. However, all objectives may not have been spelt out explicitly in the central bank legislation but may evolve through traditions and tacit understanding between the government, the central bank and other major institutions in an economy. Of late, however, considerations of financial stability have assumed increasing importance in monetary policy. The most serious economic downturns in the recent years appear to be generally associated with financial instability. The important questions for policy in the context of financial instability are the origin and the transmission of different types of shocks in the financial system, the nature and the extent of feedback in policy and the effectiveness of different policy instruments. Transmission Mechanism Monetary policy is known to have both short and long-term effects. While it generally affects the real sector with long and variable lags, monetary policy actions on financial markets, on the other hand, usually have important short-run implications. Typical lags after which monetary policy decisions begin to affect the real sector could vary across countries. It is, therefore, essential to understand the transmission mechanism of monetary policy actions on financial markets, prices and output. Central banks form their own views on the transmission mechanism based on empirical evidence, and their monetary strategies and tactics are designed, based on these views. However, there could be considerable uncertainties in the transmission channels depending on the stages of evolution of financial markets and the nature of propagation of shocks to the system. The four monetary transmission channels, which are of concern to policy makers are: the quantum channel, especially relating to money supply and credit; the interest rate channel; the exchange rate channel, and the asset prices channel. Monetary policy impulses under the quantum channel affect the real output and price level directly through changes in either reserve money, money stock or credit aggregates....
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