The following points highlight the six main objectives of monetary policy in India. The objectives are: 1. High employment 2. Economic growth 3. Price stability 4. Interest-rate stability 5. Stability of financial markets 6. Stability in foreign exchange markets.
Objective # 1. High employment:
Any modern government is committed to promote high employment.
High employment is a desirable goal of monetary policy for two main reasons:
(1) high unemployment causes much human misery, with families suffering financial distress and loss of personal self- respect,
(2) secondly, when unemployment is high, the economy has not only idle workers but also idle resources (closed factories and unused equipment), resulting in a loss of output (lower GDP). So, society’s actual output or GDP will be less than its potential (full employment) output.
At first, it might seem that full employment is the point at which no worker is’ out of a job, that is, when unemployment is zero. But, this definition ignores the fact that some unemployment, called fractional unemployment, is beneficial to the economy.
For example, a worker who decides to look for a better job might be unemployed for a while .during the job search Workers often voluntarily decide to leave work temporarily to pursue other activities (raising a family, travel, returning to school), and when they decide to re-enter the job market, it again takes some time for them to find the right job.
The goal for high employment should, therefore, not seek an unemployment level of zero, but rather a level above zero consistent with full employment at which the demand for labour equals the supply of labour. Economists call this the natural rate of unemployment.
Objective # 2. Price stability:
Over the past two decades, macroeconomists have become more aware of the social and economic costs of inflation and more concerned with a stable price level as a goal of economic policy. Price stability is desirable in a developing country like India, because a rising price level (inflation) creates considerable uncertainty in the economy.
For example the information conveyed by the prices of goods and services is harder to interpret when the overall level of prices is changing, which complicates decision making for consumers, businesses and governments at different levels.
Inflation also makes it difficult to plan for the future. For example it is more difficult to decide how much funds should be put aside to provide for one’s children’s college education in an inflationary environment.
Furthermore inflation may strain a country’s social fabric. Conflict may result because each group in the society may compete with other groups to make sure that its wages keep up with the rising level of prices.
Objective # 3. Interest-rate stability:
Interest-rate stability is desirable because fluctuations in interest rates can create uncertainty in the economy and make it more and more difficult to plan for the future. Fluctuations in interest rates also affect consumers’ willingness to buy durable goods, such as houses, motor cars, refrigerators, washing machines or even personal computers.
Objective # 4. Stability of financial markets:
A major reason for the creation of the central bank is that it can promote a more stable financial system. One way in which the central bank promotes stability is helping prevent financial panics (particularly bank failure) through its role as lender of last resort. The central bank is the ultimate source of funds in the money market.
Objective # 5. Stability in foreign exchange markets:
With the increasing importance of international trade to the Indian economy, the value of the rupee relative to other currencies has become a major consideration for the RBI. A rise in the value of the rupee makes Indian industries less competitive with those abroad, and declines in the value of the rupee stimulate inflation in India.
In addition, preventing large changes in the value of the rupee makes it easier for firms and individuals purchasing or selling goods abroad to plan ahead. Stabilising extreme movements in the value of the rupee in foreign exchange markets is thus viewed as a worthy goal of monetary policy.
Objective # 6. Economic growth:
The goal of steady economic growth is closely related to the high employment goal, because businesses are more likely to invest in capital equipment to increase productivity and economic growth when unemployment is low. Conversely, if unemployment is high and factories are idle, it does not pay for a firm to invest in additional plants and equipment.
Although the two goals are closely related, policies can be specifically aimed at promoting economic growth by directly encouraging firms to invest or by encouraging people to save, which provides more funds for firms to invest.
Conclusion: Conflict among goals:
Although many of the goals of monetary policy are consistent with each other — high employment with economic growth, interest-rate stability with financial market stability—this is not always the case. The goal of price stability often conflicts with the goals of interest-rate stability and high employment in the short run.
For example, when the economy is expanding and unemployment is falling, both inflation and interest rates may start to rise. If the RBI tries to prevent a rise in interest rates by buying bonds bidding up their prices and thus causing interest rates to fall, the resulting open market purchases will cause the monetary base, i.e., the supply of high-powered money (= currency + reserves) and the money supply to rise thereby stimulating inflation.
But, if the RBI slows down money supply growth to prevent inflation, in the short run both interest rates and unemployment may rise. The conflict among goals may thus present the central bank with some hard choices.