Evolution of monetary policy approaches: A case study of Indian economy

• Published date: 01 February 2021
• Author: Masudul Hasan Adil,Niranjan Rajadhyaksha
• Date: 01 February 2021
• DOI: http://doi.org/10.1002/pa.2113

ACADEMIC PAPER

Evolution of monetary policy approaches: A case study of

Indian economy

Masudul Hasan Adil

1

|Niranjan Rajadhyaksha

2

1

Mumbai School of Economics and Public

Policy, University of Mumbai, Mumbai, India

2

Senior Fellow, Research Program

Department, IDFC Institute, Mumbai, India

Correspondence

Masudul H. Adil, Mumbai School of Economics

and Public Policy, University of Mumbai,

400098 Mumbai, India.

Email: adilmasood.ailg@gmail.com

The monetary policy framework of India has undergone several transformations

reflecting underlying macroeconomic and financial conditions as also the dominant

socio-politico-economic paradigm. The present study makes pertinent commentary

notes on different monetary policy approaches, including, for instance, the era of

development planning, the era of monetarism, the era of multiple indicator approach,

and the era of inflation targeting in India along with their respective advantages and

disadvantages.

JEL CLASSIFICATION

E52; E58; E5

1|INTRODUCTION

One of the important tasks of the central bank is to keep demand

from either growing too rapidly with resulting inflation or too slowly

with resulting high unemployment and slow economic growth. Hence,

policy should be conducted in a way that leads to stable growth in

aggregate demand. This ultimately helps to achieve different macro-

economic goal variables in the economy.

1

To this end, macroeconomic

policymakers usually utilize a combination of fiscal policy and mone-

tary policy to manage aggregate demand in any economy. However,

as time passes, the policy regime keeps changing depending upon the

needs at that time. Here, broadly speaking, the study focuses on four

different eras of Indian monetary policy which have been followed by

India's central banks—the Reserve Bank of India (RBI)—at different

points in time.

To comprehend the Indian monetary policy better, one should

look at the legal mandate of monetary policy in India. The RBI Act

1934 holds that RBI is legally mandated, “to regulate the issues of

banknotes and keeping of reserves with a view to securing monetary

stability in India and generally to operate the currency and credit sys-

tem of the country to its advantage, to have a modern monetary pol-

icy framework to meet the challenge of an increasingly complex

economy, and to maintain price stability while keeping in mind the

objective of growth”(RBI Act, 1934). Upon closer look, it is clear that

it is a dual mandate. First, RBI has to keep inflation under control. Sec-

ond, it has to meet the credit needs of the economy. Therefore, mon-

etary policy thinking and practices in India have evolved based on

these two mandates, which are keeping inflation under control and

providing credit to the economy. Two key issues are mentioned below

which have remained in focus in almost every different era of Indian

monetary policy.

1 How should the two objectives of price stability and economic

growth be balanced?

2 What policy instruments shouldbe used to meetthese two

objectives?

There are four distinct eras in terms of these two questions.

Should RBI be focussed on price stability or on economic growth? This

is the classic problem in the macroeconomic policy of matching eco-

nomic policy goals with policy instruments. And this is where the cur-

rent study focusses here on four distinct eras of monetary policy in

India. The present study maintains the objective to focus on those

four eras and their evolution at different points in time, including how

monetary policy in India shifted over different eras since its inception.

1.1 |The era of development planning

India embarked on the road of development planning in 1951. Soon

after independence was the time when the first 5-year plan was

launched. Subsequently, 5-year plans were the centerpiece of India's

development strategy. The question is what was the role envisaged

for monetary policy in this entire development planning framework.

Received: 15 November 2019Accepted: 8 March 2020

DOI: 10.1002/pa.2113

J Public Affairs. 2021;21:e2113.wileyonlinelibrary.com/journal/pa© 2020 John Wiley & Sons, Ltd1of8

https://doi.org/10.1002/pa.2113