Large-scale asset purchases (also known as quantitative easing) by a central bank involve the purchase of long-term government bonds financed by credit reserve accounts that commercial banks hold with the central bank. This purchase would reduce government bond yields and indicate that the key interest rate will remain at a lower level for an extended period of time. Bond sellers, in turn, can switch investment portfolios and invest in riskier assets (e.B corporate bonds), resulting in a lower relevant interest rate and higher asset prices, thereby stimulating economic growth. Central banks can also acquire assets from the private sector. Vasudevan, A. (2017). Reflections on Analytical Monetary Policy Issues: India`s Economic Realities. Economic and Political Weekly, 52(12), 45-52. Monetary transmission increased somewhat following the introduction of the external reference system in October 2019, where most banks linked their lending rates to the Reserve Bank`s key interest rate.
From October to December 2019, national banks` WALRs for new loans in rupees decreased by 18 basis points for housing loans, by 87 basis points for car loans and by 23 basis points for loans to micro, small and medium-sized enterprises (MSMEs). It should be noted that prior to the establishment of the GPP in 2005, a Technical Advisory Committee (TAC) on Monetary Policy was established, composed of external experts from the fields of monetary economics, central banks, financial markets and public finance. The task of this committee was to improve the monetary policy consultation process by reviewing macroeconomic and monetary developments in the economy and advising the RBI on the monetary policy stance. With the formation of the MPC, the TAC on monetary policy ceased to exist. Instruments are instruments over which the central bank has control and which are used to achieve the operational objective. Examples of instruments are open market operations, reserve requirements, discount policy, loans to banks, key interest rates. Operational objectives are the financial variables that can be largely controlled by the central bank through monetary policy instruments and that guide the day-to-day operations of the central bank. These can have an impact on the intermediate objective and thus contribute to the achievement of the final objective of monetary policy.
Examples of operational objectives include reserve currency and short-term money market interest rates. The objective of monetary policy in the early years of the creation of the RBI was mainly to maintain the parity of the pound sterling, the exchange rate being the nominal anchor of monetary policy. Liquidity was regulated by open market operations (OMO), bank interest rates and the cash reserve ratio (CRR). Shortly after independence and in the late 1960s, the role of the central bank was aligned with the nation`s planned development process in accordance with the 5-year plans. Therefore, it has played an important role in regulating the availability of credit, using OMO, bank interest rates and reserve requirements for this purpose. Reserve Bank of India. (2013). Report on Currency and Finance 2009-2012: Budgetary-Monetary Coordination. Mumbai (Bombay). This operational framework is illustrated in Fig.
2. (The definitions of the variables shown in Figure 2 are given in Appendix 1). The main instruments in this context were the cash reserve ratio (CRR), open market operations (OOMO), refinancing facilities and foreign exchange operations. The broad money supply (M3) was chosen as the intermediate target, while the reserve money supply (M0) was the main operational target. However, an analysis of the results of monetary growth during the monetary policy framework shows that the objectives have rarely been achieved (RBI 2009-2012). Despite the rise in the CRR, money supply growth remained high and fueled inflation. The Monetary Policy Committee has also been in place since October 2016. The GPP`s mandate is to set the overall repo rate taking into account the main objective of monetary policy – to maintain price stability while taking into account the growth target – as well as the inflation target within the tolerance range. Once the key interest rate is set, the process of transmitting monetary policy facilitates the flight of changes in the key interest rate to all financial markets (money and bond markets) as well as to the banking sector, which further affects interest-sensitive spending in the economy and, ultimately, increases aggregate demand and production growth. Section 4 deals with a general framework for the transmission of monetary policy and applies the framework to India. It also describes the global interest rate links. Section 5 examines unconventional monetary policy measures taken in late 2019 and early 2020.
Section 6 completes the document. This general framework will be applied to the target monetary policy framework with feedback from 1985 to 1998 and to the inflation-targeting framework in place from 2016 onwards. The multi-indicator approach, applicable from 1998 to 2016, was based on a number of financial and economic variables and was not precisely specified on the basis of this framework, although the broad money supply was treated as an intermediate objective and the objectives of monetary policy are the same in the different frameworks. The amended RBI Act of 1934 provides a legal and institutionalized framework for a six-member Monetary Policy Committee (MPC), which is formed by the central government by notification to the Official Gazette. The central government thus formed the OAG in September 2016 with three members of the RBI, including the Governor as Chairman, and three external members in accordance with the Gazette notification of 29 September 2016 (details of the composition of the OAG are set out in Annex 3). The Committee must meet at least four times a year, although it has met every two months since October 2016. Each member of the OAG shall have one vote, and in the event of a tie, the Governor shall have a second or decisive vote. The resolution adopted by the OAG will be issued at the end of each OAG meeting. On the 14th day, the minutes of the CMP`s deliberations will be published, which will include the resolution adopted by the PMO, each member`s vote on the resolution and each member`s statement on the resolution.
In the end, no alternative was better than a flexible inflation target. But we have learned important lessons from other approaches. We have incorporated these lessons into the way we conduct monetary policy. Monetary transmission in different markets is illustrated in Figures 8, 9 and 10. Figure 8 shows the policy corridor with the MSF rate as the upper limit and the reverse repo rate as the lower limit for the daily movement of the weighted average overnight rate. The figure shows that the WACR has moved closely with the key interest rate (repo rate). Figure 9 shows that interest rates in the G-Sec market have followed movements in the key interest rate. Figure 10 shows that the direction of change in the rcLR was more or less the same as that of the repo rate. The WALR for fresh rupee loans continued the repo rate much more than the WALR for outstanding loans. The renewed monetary policy agreement ensures continuity and clarity and strengthens the framework to reflect the realities of the world in which we live. And it will continue to support the Bank`s main objective of keeping inflation low and stable over time.
In preparation for the 2021 renewal, our researchers examined the effectiveness of the monetary policy framework, evaluated other frameworks, and learned from the experiences of other central banks. Former RBI Governor Dr. Raghuram Rajan established a committee of experts in 2013 to review and strengthen the monetary policy framework (RBI 2014; Chair: Dr. Urjit R. Patel). One of the Committee`s tasks was to examine the objectives and implementation of monetary policy in a globalized and highly interconnected environment. The Committee was also required to review the organizational structure, monetary policy framework and instruments, as well as the liquidity management framework, in order to ensure compatibility with macroeconomic and financial stability and market developments. Obstacles to the transmission of monetary policy should be identified and institutional measures and conditions to improve transmission between financial markets and the real economy should be proposed. To illustrate first-type monetary transmission, we examine the impact of a cumulative 135 basis point cut in the policy interest rate between February 2019 and January 2020. During this period, transmission to various money and bond markets ranged from 146 basis points in the overnight call money market to 73 basis points in the 5-year government bond market to 76 basis points in the 10-year government bond market. The transfer to the credit market was also modest, with the 1-year median marginal cost of the fund-based lending rate (LCM) falling by 55 basis points in February 2019 and January 2020. The weighted average borrowing rate (WALR) on new bank-sanctioned rupee loans fell by 69 basis points, while the WALR for outstanding rupee loans fell by 13 basis points from February to December 2019.
Needless to say, in these unprecedented times of global pandemic (and usually in times of severe crisis), a multi-pronged approach is needed that includes monetary, fiscal, and other measures to protect economic activity and minimize the negative impact of the pandemic (crisis) on economic growth. .
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