Reserve Bank of India Definition The central bank of India, founded in 1935, which maintains the monetary policy

of its national currency, the rupee, and the nation's currency reserves. It is a member of the Asian Clearing Union. The primary function of this establishment is to regulate the issuing of bank notes to ensure secure monetary stability in India.

Meaning A central bank, reserve bank, or monetary authority is an institution that manages a state's currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the amount of money in the nation, and usually also prints the national currency, which usually serves as the nation's legal tender.[1][2] Examples include the European Central Bank (ECB) and the Federal Reserve of the United States.[3] The primary function of a central bank is to manage the nation's money supply (monetary policy), through active duties such as managing interest rates, setting the reserve requirement, and acting as a lender of last resort to the banking sector during times of bank insolvency or financial crisis. Central banks usually also have supervisory powers, intended to prevent bank runs and to reduce the risk that commercial banks and other financial institutions engage in reckless or fraudulent behavior. Central banks in most developed nations are institutionally designed to be independent from political interference

Introduction:A.RESERVE BANK OF INDIA (RBI) :The Reserve Bank of India is the central bank of India it was established as a shareholders bank on 1st April 1935. Its share capital was Rs. 5 crore, divided in to 5 lakhs fully paid up shares of Rs. 100 each. On 1st January 1949 it was nationalized. Its headquarters is at Mumbai. RBI, like any other bank performs almost all traditional Central banking functions. Due to countrys development it has also undertaken developmental and promotional functions.

The Reserve Bank of India (RBI) is India's central banking institution, which controls the monetary policy of the Indian rupee. It was established on 1 April 1935 during the British Raj in accordance with the provisions of the Reserve Bank of India Act, 1934.[2] The share capital was divided into shares of 100 each fully paid, which was entirely owned by private shareholders in the beginning.[3] Following India's independence in 1947, the RBI was nationalized in the year 1949. The RBI plays an important part in the development strategy of the Government of India. It is a member bank of the Asian Clearing Union. The general superintendence and direction of the RBI is entrusted with the 21-member-strong Central Board of Directorsthe Governor(currently Raghuram Rajan), four Deputy Governors, two Finance Ministry representative, ten governmentnominated directors to represent important elements from India's economy, and four directors to represent local boards headquartered at Mumbai, Kolkata, Chennai and New Delhi. Each of these local boards consists of five members who represent regional interests, as well as the interests of co-operative and indigenous banks. History 19351950

The old RBI Building in Mumbai The Reserve Bank of India was founded on 1 April 1935 to respond to economic troubles after the First World War. It began according to the guidelines laid down by Dr. Ambedkar. RBI was conceptualized as per the guidelines, working style and

outlook presented by Ambedkar in front of the Hilton Young Commission. When this commission came to India under the name of Royal Commission on Indian Currency & Finance, each and every member of this commission were holding Ambedkars book titled The Problem of the Rupee Its origin and its solution.[4] The bank was set up based on the recommendations of the 1926 Royal Commission on Indian Currency and Finance, also known as the HiltonYoung Commission.[5] The original choice for the seal of RBI was The East India Company Double Mohur, with the sketch of the Lion and Palm Tree. However it was decided to replace the lion with the tiger, the national animal of India. The Preamble of the RBI describes its basic functions to regulate the issue of bank notes, keep reserves to secure monetary stability in India, and generally to operate the currency and credit system in the best interests of the country. The Central Office of the RBI was initially established in Calcutta (now Kolkata), but was permanently moved to Bombay (now Mumbai) in 1937. The RBI also acted as Burma's central bank, except during the years of the Japanese occupation of Burma (194245), until April 1947, even though Burma seceded from the Indian Union in 1937. After the Partition of India in 1947, the Bank served as the central bank for Pakistan until June 1948 when the State Bank of Pakistan commenced operations. Though originally set up as a shareholders bank, the RBI has been fully owned by the Government of India since its nationalization in 1949.[6] 19501960[edit source | editbeta] In the 1950s, the Indian government, under its first Prime Minister Jawaharlal Nehru, developed a centrally planned economic policy that focused on the agricultural sector. The administration nationalized commercial banks[7] and established, based on the Banking Companies Act of 1949 (later called the Banking Regulation Act), a central bank regulation as part of the RBI. Furthermore, the central bank was ordered to support the economic plan with loans.[8] 19601969 As a result of bank crashes, the RBI was requested to establish and monitor a deposit insurance system. It should restore the trust in the national bank system and was initialized on 7 December 1961. The Indian government founded funds to promote the economy and used the slogan "Developing Banking". The government of India restructured the national bank market and nationalized a lot of institutes. As a result, the RBI had to play the central part of control and support of this public banking sector.

19691985 In 1969, the Indira Gandhi-headed government nationalized 14 major commercial banks. Upon Gandhi's return to power in 1980, a further six banks were nationalized.[5] The regulation of the economy and especially the financial sector was reinforced by the Government of India in the 1970s and 1980s.[9] The central bank became the central player and increased its policies for a lot of tasks like interests, reserve ratio and visible deposits.[10] These measures aimed at better economic development and had a huge effect on the company policy of the institutes. The banks lent money in selected sectors, like agri-business and small trade companies.[11] The branch was forced to establish two new offices in the country for every newly established office in a town.[12] The oil crises in 1973 resulted in increasing inflation, and the RBI restricted monetary policy to reduce the effects.[13] 19851991 A lot of committees analysed the Indian economy between 1985 and 1991. Their results had an effect on the RBI. The Board for Industrial and Financial Reconstruction, the Indira Gandhi Institute of Development Research and the Security & Exchange Board of India investigated the national economy as a whole, and the security and exchange board proposed better methods for more effective markets and the protection of investor interests. The Indian financial market was a leading example for so-called "financial repression" (Mackinnon and Shaw).[14] The Discount and Finance House of India began its operations on the monetary market in April 1988; the National Housing Bank, founded in July 1988, was forced to invest in the property market and a new financial law improved the versatility of direct deposit by more security measures and liberalisation.[15] 19912000 The national economy came down in July 1991 and the Indian rupee was devalued.[16] The currency lost 18% relative to the US dollar, and the Narsimahmam Committee advised restructuring the financial sector by a temporal reduced reserve ratio as well as the statutory liquidity ratio. New guidelines were published in 1993 to establish a private banking sector. This turning point should reinforce the market and was often called neo-liberal.[17] The central bank deregulated bank interests and some sectors of the financial market like the trust and property markets.[18] This first phase was a success and the

central government forced a diversity liberalisation to diversify owner structures in 1998.[19] The National Stock Exchange of India took the trade on in June 1994 and the RBI allowed nationalized banks in July to interact with the capital market to reinforce their capital base. The central bank founded a subsidiary companythe Bharatiya Reserve Bank Note Mudran Limitedin February 1995 to produce banknotes.[20] Since 2000 The Foreign Exchange Management Act from 1999 came into force in June 2000. It should improve the foreign exchange market, international investments in India and transactions. The RBI promoted the development of the financial market in the last years, allowed online banking in 2001 and established a new payment system in 20042005 (National Electronic Fund Transfer).[21]The Security Printing & Minting Corporation of India Ltd., a merger of nine institutions, was founded in 2006 and produces banknotes and coins.[22] The national economy's growth rate came down to 5.8% in the last quarter of 20082009[23] and the central bank promotes the economic development.[2

Structure

RBI runs a monetary museum in Mumbai Central Board of Directors The Central Board of Directors is the main committee of the central bank. The Government of India appoints the directors for a four-year term. The Board consists of a governor, four deputy governors, fifteen directors to represent the

regional boards, one from the Ministry of Finance and ten other directors from various fields. The Government nominated Arvind Mayaram, as a director of the Central Board of Directors with effect from August 7, 2012 and vice R Gopalan, RBI said in a statement on August 8, 2012. .[25] The Central Government has nominated Shri Rajiv Takru, Secretary, Department of Financial Services, Ministry of Finance, New Delhi as a director on the Central Board of Directors of the Reserve Bank of India vice Shri D. K. Mittal. Shri Takru's nomination is with effect from February 4, 2013 and until further orders.[26] Governors The current Governor of RBI is Raghuram Rajan. There are four deputy governors, Deputy Governor K C Chakrabarty, Urjit Patel, Shri Anand Sinha andShri H.R. Khan . Deputy Governor K C Chakrabarty's term has been extended further by 2 years. Subir Gokarn was replaced by Mr. Urjit Patel in January 2013.[27] Supportive bodies The Reserve Bank of India has ten regional representations: North in New Delhi, South in Chennai, East in Kolkata and West in Mumbai. The representations are formed by five members, appointed for four years by the central government and servebeside the advice of the Central Board of Directorsas a forum for regional banks and to deal with delegated tasks from the central board.[28] The institution has 22 regional offices. The Board of Financial Supervision (BFS), formed in November 1994, serves as a CCBD committee to control the financial institutions. It has four members, appointed for two years, and takes measures to strength the role of statutory auditors in the financial sector, external monitoring and internal controlling systems. The Tarapore committee was set up by the Reserve Bank of India under the chairmanship of former RBI deputy governor S. S. Tarapore to "lay the road map" to capital account convertibility. The five-member committee recommended a three-year time frame for complete convertibility by 19992000. On 1 July 2007, in an attempt to enhance the quality of customer service and strengthen the grievance redressal mechanism, the Reserve Bank of India created a new customer service department.

Offices and branches The Reserve Bank of India has four zonal offices.[29] It has 19 regional offices at most state capitals and at a few major cities in India. Few of them are located in Ahmedabad, Bangalore, Bhopal,Bhubaneswar, Chandigarh, Chennai, Delhi, Gu wahati, Hyderabad, Jaipur, Jammu, Kanpur, Kolkata, Lucknow, Mumbai, Nagpur, P atna, and Thiruvananthapuram. Besides it has 09 sub-offices atAgartala, Dehradun, Gangtok, Kochi, Panaji, Raipur, Ranchi, Shillong, Shimla and Srinagar. The bank has also two training colleges for its officers, viz. Reserve Bank Staff College at Chennai and College of Agricultural Banking at Pune. There are also four Zonal Training Centres atMumbai, Chennai, Kolkata and New Delhi.

A. FUNCTIONS OF RBI :RBI performs many functions, some of them are:1. Issue Of Currency Notes :Under section 22 of RBI Act, the bank has the sole right to issue currency notes of all denominations except one rupee coins and notes. The one-rupee notes and coins and small coins are issued by Central Government and their distribution is undertaken by RBI as the agent of the government. The RBI has a separate issue department which is entrusted with the issue of currency notes. 2. Banker To The Government :The RBI acts as a banker agent and adviser to the government. It has obligation to transact the banking business of Central Government as well as State Governments. E.g.:- RBI receives and makes all payments on behalf of government, remits its funds, buys and sells foreign currencies for it and gives it advice on all banking matters. RBI helps the Government both Central and state to float new loans and manage public debt. The bank makes ways and meets advances of the government. On behalf of central government it sells treasury bills and thereby provides short-term finance.

3. Bankers bank And Lender Off Last Resort :RBI acts as a banker to other banks. It provides financial assistance to scheduled banks and state co-operative banks in form of rediscounting of eligible bills and loans and advances against approved securities. RBI acts as a lender of last resort. It provides funds to bank when they fail to get it from other sources. It also acts as a clearing house. Through RBI, banks make interbanks payments. 4. Controller Of Credit :RBI has power to control the volume of credit created by banks. The RBI through its various quantitative and qualitative techniques regulates total supply of money and bank credit in the interest of economy. RBI pumps in money during busy season and withdraws money during slack season. 5. Exchange control And Custodian Of Foreign Reserve :RBI has the responsibility of maintaining fixed exchange rates with all member countries of IMF. For this, RBI has centralized all foreign exchange reserves (FOREX). RBI functions as custodian of nations foreign exchange reserves. It has to maintain external valu of Rupee. RBI achieves this aim through appropriate monetary fiscal and trade policies and exchange control. 6. Collection And Publication Of Data :The RBI collects and complies statistical information on banking and financial operations of the economy. The Reserve Bank Of India Bulletian is a monthly publication. It not only provides information, but also results of important studies and investigations conducted by reserve bank are given. The Report on currency and finance is an annual publication. It provides review of various developments of economic and financial importance. 7. Regulatory And Supervisory Functions :The RBI has wide powers of supervision and control over commercial and cooperative banks, relating to licensing, establishment, branch expansion, liquidity of Assets, management and methods of working, amalgamation, re-construction and liquidation. The supervisory functions of RBI have helped a great in improving the standard of banking in India to develop on sound lines and to improve the methods of their operation.

8. Clearing House Functions :The RBI acts as a clearing house for all member banks. This avoids unnecessary transfer of funds between the various banks. 9. Development And Promotional Functions :The RBI has helped in setting up Industrial Finance Corporations of India (IFCI), State Financial Corporations (SFCs), Deposit Insurance Corporation, Agricultural Refinance and Development Corporation (ARDC), units Trust of India (UTI) etc. these institutions were set up to mobilize savings, promote saving habits and to provide industrial and agricultural finance. RBI has a special Agricultural Credit Department (ACD) which studies the problems of agricultural credit. For this Regional Rural banks, Co-operative, NABARD etc. were established. The RBI has also taken measures to promote organized bill market to create elasticity in Indian Money Market in order to satisfy seasonal credit needs. Thus RBI has contributed to economic growth by promoting rural credit, industrial financing, export trade etc.

Main functions 1) Bank of Issue Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of all denominations. The distribution of one rupee notes and coins and small coins all over the country is undertaken by the Reserve Bank as agent of the government. The Reserve Bank has a separate Issue Department which is entrusted with the issue of currency notes. The assets and liabilities of the Issue Department are kept separate from those of the Banking Department. 2) Monetary authority The Reserve Bank of India is the main monetary authority of the country and beside that the central bank acts as the bank of the national and state governments. It formulates, implements and monitors the monetary policy as well as it has to ensure an adequate flow of credit to productive sectors.

3) Regulator and supervisor of the financial system The institution is also the regulator and supervisor of the financial system and prescribes broad parameters of banking operations within which the country's banking and financial system functions.Its objectives are to maintain public confidence in the system, protect depositors' interest and provide cost-effective banking services to the public. The Banking Ombudsman Scheme has been formulated by the Reserve Bank of India (RBI) for effective addressing of complaints by bank customers. The RBI controls the monetary supply, monitors economic indicators like the gross domestic product and has to decide the design of the rupee banknotes as well as coins.[31] 4) Managerial of exchange control The central bank manages to reach the goals of the Foreign Exchange Management Act, 1999. Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India. 5) Issuer of currency The bank issues and exchanges or destroys currency notes and coins that are not fit for circulation. The objectives are giving the public adequate supply of currency of good quality and to provide loans to commercial banks to maintain or improve the GDP. The basic objectives of RBI are to issue bank notes, to maintain the currency and credit system of the country to utilize it in its best advantage, and to maintain the reserves. RBI maintains the economic structure of the country so that it can achieve the objective of price stability as well as economic development, because both objectives are diverse in themselves. 6) Banker of Banks RBI also works as a central bank where commercial banks are account holders and can deposit money.RBI maintains banking accounts of all scheduled banks.[32] Commercial banks create credit. It is the duty of the RBI to control the credit through the CRR, bank rate and open market operations. As banker's bank, the RBI facilitates the clearing of cheques between the commercial banks and helps inter-bank transfer of funds. It can grant financial accommodation to schedule banks. It acts as the lender of the last resort by providing emergency advances to the banks. It supervises the functioning of the commercial banks and take action against it if need arises.

8 most important functions of a Central Bank of India

Central banking functions have evolved gradually over decades. Their evolution has been guided by ever-changing need to find new methods of regulating, guiding and helping the financial system (particularly, the banks). In other words, the evolution of central banking functions has tended to coincide with the evolution of the financial systems of the world economies. Let us recount the leading functions. 1. Note Issue: It is considered one of the primary functions of a central bank. The entire financial system of a country, with ever-increasing volume and variety of the financial instruments, institutions and markets, needs a stable supply of legal tender money. This legal tender should tend to vary, both in volume and composition to the changing requirements of the economy. Accordingly, the central bank of the country is granted the sole right to issue currency (including that of the government of the country) and (ii) a monopoly of issuing bank notes (which are its promises to pay). 2. Banker's Bank: The second main function of a central bank is that of being a bank of the banks. This function includes the following interrelated sub-functions. (a) The first sub-function is its being a custodian of the cash reserves of the commercial banks. The exact form of this function has varied from country to country and in terms of legal provisions. Historically, commercial banks discovered that it was convenient and economical to hold deposit balances with the central bank for making payments to each other. In some countries, however, the banks are compelled by law to hold deposit balances with the central bank and this gives it an additional tool to regulate credit creation by them. The legal provision to this effect was first introduced in US. Later, it was adopted in India also. RBI has found it a very effective regulatory tool and has used it very extensively.

To begin with, bank deposits were categorised into demand deposit liabilities and time deposit liabilities. The minimum cash balances to be maintained with RBI were to be between 2% and 8% of the time deposit liabilities and between 5% and 20% of demand deposit liabilities. The choice of exact percentages and their revision was left to the discretion of the RBI. Later on, the provision relating to minimum cash balances (called 'cash reserve ratio', or CRR) was modified to the effect that now a uniform percentage (between 3% and 15%) is applicable to all bank deposits. Again, the choice of exact percentage and its revision is left to the discretion of the RBI. (b) The second sub-function is that of clearance. When individual banks maintain deposit balances with the central bank and use them to make payments to each other, the system of interbank clearance emerges. The interbank clearance and remittances result in appropriate adjustments in the deposit balances of the banks with the central bank. Actually, the basic motive, which induces the commercial banks in maintaining deposit balances with the central bank, is the convenience and economy of making payments to each other. This function was first developed by the Bank of England in mid 19th century. Currently, it is one of the primary functions of every central bank of the world. 3. The Central Bank: The central bank is the final source of the supply of legal tender. It is the lender of the last resort. For this reason, it should be able to adjust the availability of currency with the market in line with the changing needs of the latter. When the economy expands and it needs additional money and credit, the central bank can adopt a policy of pumping in additional currency in the market. Similarly, it can try to curtail the supply of available currency when the economy in a phase of contraction. The central bank adjusts the volume of currency in two ways. (i) The banks can approach it for cash loans. It can tighten the terms of issue of such loans (including the rate of interest to be charged) if it wants to restrict the money supply. Alternatively, it can make it easier and cheaper for the banks to borrow if it wants to increase the supply of money and credit. (ii) The amount of money needed by the market is also reflected in the bills drawn by the seller upon the buyers and the central bank can take steps to alter the money supply in the market by adjusting the volume of bills discounted/ rediscounted by it. For example, when the volume of bills drawn is increasing during

an expansionary phase of the economy, the central bank can adopt the policy of discounting more of them and pumping additional currency in the market. Similarly, when the economy is passing through a phase of contraction, the volume of bills drawn decreases. In this case, the central bank can drain the market of excess money supply by collecting the earlier discounted bills and discounting less of fresh bills. In addition, it can also adopt the policy of adjusting its discount rate to encourage or discourage the discounting of bills, as the need be. 4. Banker to the Government: The central bank of the country happens to be a banker to the government. This function normally involves two things: (i) providing ordinary banking services to the government, and (ii) being a public debt agent and underwriter to the government. Let us consider each of these with reference to the Reserve Bank of India. 5. Custodian of Foreign Exchange Reserves: Central bank of a country is also a custodian of its official foreign exchange reserves. This arrangement helps the authorities in managing and co-ordinating the monetary matters of the country more effectively. This is because there is a direct association between foreign exchange reserves and quantity of money in the market. The foreign exchange reserves are influenced by international capital movements, international trade credits and so on. Because of the interaction between the domestic money supply, price level and exchange reserves, the central bank frequently faces several contradictory tendencies which have to be reconciled. 6. Regulation of Exchange Rate: A related function, which is assigned to the central bank, is the regulation and stabilization of the exchange rate. This task is facilitated when the central bank is also the custodian of official foreign exchange reserves. The need for a stable exchange rate is more in the case of a paper standard than under a metallic standard. In this context, we should specifically note two things: (i) the justification for having a stable exchange rate and avoiding violent and wide fluctuations in it; and (ii) the need to assign this task to an expert and competent agency.

As regards expertise and competence central bank of the country is the best agency to which the task of regulating and stabilizing exchange rate should be assigned. The central bank happens to be the apex institution of the entire financial system of the country. It is in possession of maximum data and has the expertise 'of estimating the financial trends and the type of corrective measures needed. Moreover, it possesses several regulatory powers over the financial system. It can contemplate and take the complementary measures needed for ensuring the success off the steps taken in the area of exchange rate. A stable exchange rate is of great help in promoting external trade and orderly capital flows. The volatility of exchange rate tends to increase if there is complete capital convertibility (that is, capital can flow in and out of the country without specific permission of the authorities). If the central bank is given the authority to regulate the use of foreign exchange (that is, if it has the authority to apply exchange control to the extent it decides), the task of stabilising exchange rate becomes easier for it. 7. Credit Control: Over the years, credit control has become a leading function of a modern central bank. In earlier days, the term credit control referred to the regulation of only the "volume" of money and credit. Currently, the term is used in a wider meaning and covers not only the "volume" of money and credit, but also its components, its flows, its allocation between alternative uses and borrowers, terms and conditions attached to credit and so on. The need for credit control arises because it is observed that "money cannot manage itself. Left to unregulated market forces, flows of money and credit have the tendency to accentuate cyclical fluctuations. Moreover, in underdeveloped countries, unregulated credit flows strengthen inter-sectoral imbalances, speculative forces and other distortions. Details of credit control and instruments used by the central bank will be discussed later in this Unit. 8. Other Functions: It is believed that an underdeveloped country requires an all-frontal approach in solving its problems of poverty and growth. Though regulation of the volume of money and credit and its other dimensions, the central bank plays a key role in its growth policy, much more is needed to make it really effective. Viewed in this

manner, the functions of a central bank come to cover a much wider field than is conventionally considered in the case of central banks of developed countries. Let us consider the developmental role of a central bank with reference to our own country. At the time of Independence, our entire financial system (including our bank jpig sector) was very weak. Modern banking services were scarcely available in rural and semi-urban areas. The, banking system contained several small and weak banks. There was a need to strengthen them through amalgamations and mergers. Similarly, the banking industry was in the grip of some unhealthy practices which risked their own lives and Jeopardised the interest of the depositors. They were in need of better regulation and supervision.

What are the roles of Reserve Bank of India? Answer: The Reserve Bank of India is the central bank of India, and was established on April 1, 1935. The RBI is fully owned by the Government of India since nationalization in 1949. The Key roles of the RBI are:

Regulator and supervisor of the financial system Manager of exchange control Issuer of currency Banker to the Government Bank to banks: maintains banking accounts of all scheduled banks

Indian banking system:-

Main Objectives of RBI are the following: Monetary Authority

Formulates implements and monitors the monetary policy Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors

Regulator and supervisor of the financial system

Prescribes broad parameters of banking operations within which the countrys banking and financial system functions Objective: maintain public confidence in the system, protect depositors interest and provide cost-effective banking services to the public.

Manager of Exchange Control

Manages the Foreign Exchange Management Act, 1999 Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign exchange market in India.

Issuer of currency

Issues and exchanges or destroys currency and coins not fit for circulation Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality.

Developmental role

Performs a wide range of promotional functions to support national objectives

Related Functions

Banker to the Government: performs merchant banking function for the central and the state governments; also acts as their banker Banker to banks: maintains banking accounts of all scheduled banks Owner and operator of the depository (SGL) and exchange (NDS) for government bonds

Evolution of Central Banking in India I. Global Evolution of Central Banking Evolution of central banking is essentially a twentieth century phenomenon as there were only about a dozen central banks in the world at the turn of the twentieth century. In contrast, at present, there are nearly 160 central banks. This is not surprising since the need for central banks obviously emerged as banking became more complex, while becoming an increasingly important part of the economy over time. The many vicissitudes experienced by banks and their depositors inevitably led to cries for their regulation. Second, central banks are essentially a nation state phenomenon, and hence proliferated as nation states themselves emerged and multiplied: again a twentieth century phenomenon. Third, it is useful to recall some of the reasons for the origin of central banks: to issue currency; to be a banker and lender to the government: to regulate and supervise the banks and financial entities: and to serve as a lender-of-last-resort. This is ironic since much of the current professional thinking is that a central bank should be independent of government, should no longer be a debt manager of the government, and should not regulate or supervise commercial banks. The new objective function assigned to the central bank is to focus on price stability, with financial stability as an additional objective in some cases. This is perhaps not surprising since price stability was historically achieved, along with preservation of currency value, through the gold standard, and later through the dollar anchor and its relation to gold. The world lost its monetary anchor on August 15, 1971 when the US decided to delink the dollar from gold, and has been floundering ever since in search of a new anchor. II. The Historical Antecedents of Central Banking in India

In India, the efforts to establish a banking institution with central banking character dates back to the late 18th century. The Governor of Bengal in British India recommended the establishment of a General Bank in Bengal and Bihar. The Bank was set up in 1773 but it was short-lived. It was in the early 20th century that, consequent to the recommendations of the Chamberlain Commission (1914) proposing the amalgamation of the three Presidency Banks, the Imperial Bank of India was formed in 1921 to additionally carry out the functions of central banking along with commercial banking. In 1926, the Royal Commission on Indian Currency and Finance (Hilton Young Commission) recommended that the dichotomy of functions and divisions of responsibilities for control of currency and credit should be ended. The Commission suggested the establishment of a central bank to be called the Reserve Bank of India, whose separate existence was considered necessary for augmenting banking facilities throughout the country. The Bill to establish the RBI was introduced in January 1927 in the Legislative Assembly, but it was dropped due to differences in views regarding ownership, constitution and composition of its Board of Directors. Finally, a fresh Bill was introduced in 1933 and passed in 1934. The RBI Act came into force on January 1, 1935. The RBI was inaugurated on April 1, 1935 as a shareholders institution and the Act provided for the appointment by the Central Government of the Governor and two Deputy Governors. The RBI was nationalized on January 1, 1949 in terms of the Reserve Bank of India (Transfer to Public Ownership) Act, 1948 (RBI, 2005b). The main functions of the RBI, as laid down in the statutes are - a) issue of currency, b) banker to Government, including the function of debt management, and c) banker to other banks. The Preamble to the RBI Act laid out the objectives as "to regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage." Unusually, and unlike most central banks the RBI was specifically entrusted with an important promotional role since its inception to finance agricultural operations and marketing of crops. In fact, the Agricultural Credit Department was created simultaneously with the establishment of the RBI in 1935. III. Development Role of the RBI As in many developing countries, the central bank is seen as a key institution in bringing about development and growth in the economy. In the initial years of the

RBI before independence, the banking network was thinly spread and segmented. Foreign banks served foreign firms, the British army and the civil service. Domestic/Indian banks were linked to domestic business groups and managing agencies, and primarily did business with their own groups. The coverage of institutional lending in rural areas was poor despite the cooperative movement. Overall financial intermediation was weak. In an agrarian economy, where more than three-fourth of the population lived in the rural areas and contributed more than half of GDP, a constant and natural concern was agricultural credit. Therefore, almost every few years a committee was constituted to examine the rural credit mechanism. There has perhaps been one committee every two or three years for over a hundred years. IV. Relationship of the RBI with the Government The RBI is a banker to the Central Government statutorily and to the State Governments by virtue of specific agreements with each of them. The loss of autonomy of the RBI that took place in early decades was not because of any conscious decision based on the currently prevalent thinking on the relationship between central banks and the Government, but rather as a consequence of overall economic policy then prevailing regarding the appropriate dominant role of the Government in the economy as a whole. Thus, it is useful to review the relationship of the Reserve Bank with the Government as it has evolved over time. V. Autonomy of the Reserve Bank of India The trend towards central bank independence is not of recent origin. In the process of evolution, globally, while the spectrum of activities of the central banks has widened, the stance regarding the independence of central banks has taken an interesting turn. Before the First World War, the central banks in most cases were private institutions and were formally independent of their governments. Interestingly, some central banks were established to serve as banker and debt manager to the government. The position changed around the Second World War - central banks in a number of countries (e.g., Germany, France, England, Japan, Italy and Sweden) were made subordinate to their governments. In recent years again, there has been a reversal in the trend. Governments have started granting more autonomy to their central banks: on the argument that a country is more likely to have low inflation if the central bank is independent. This argument has

its roots in the breakdown of gold standard in early 1970s and the phase of high inflation that followed during the 1970s and 1980s. To achieve price stability, increasingly, central banks were granted autonomy along with an inflation target to meet, implying that independence was saddled with accountability. To illustrate, the Bank of England, which had substantial independence for much of the eighteenth and nineteenth century, but was later made subservient to the government, was legally granted independence in June 1998 but with an inflation target to achieve. The recent trend towards central bank independence has been influenced greatly by the experience of the Bundes Bank and Reserve Bank of New Zealand.

Monetary policy of Reserve Bank of India

Definition of 'Monetary Policy' The actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as increasing the interest rate, or changing the amount of money banks need to keep in the vault (bank reserves). Definition Economic strategy chosen by a government in deciding expansion or contraction in the country's money-supply. Applied usually through the central bank, a monetary policy employs three major tools: (1) buying or selling national debt, (2) changing credit restrictions, and (3) changing the interest rates by changing reserve. Monetary policy plays the dominant role in control of the aggregate-demand and, by extension, of inflation in an economy. Also called monetary regime. See also monetarism.

Meaning:Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.[1][2] The official goals usually include relatively stable prices and low unemployment. Monetary theory provides insight into how to craft optimal monetary policy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in order to avoid the resulting distortions and deterioration of asset values.

A) MONETARY POLICY :Monetary policy is a regulatory policy by which the central bank or monetary authority of a country controls the supply of money, availability of bank credit and cost of money, that is, the rate of Interest. Monetary policy / monetary management is regarded as an important tool of economic management in India. RBI controls the supply of money and bank credit. The Central bank has the duty to see that legitimate credit requirements are met and at the same credit is not used for unproductive and speculative purposes. RBI rightly calls its credit policy as one of controlled expansion. B) OBJECTIVES OF MONETARY POLICY OF INDIA :The main objective of monetary policy in India is growth with stability. Monetary Management regulates availability, cost and use of money and credit. It also brings institutional changes in the financial sector of the economy. Following are the main objectives of monetary policy in India :1. Growth With Stability :Traditionally, RBIs monetary policy was focused on controlling inflation through contraction of money supply and credit. This resulted in poor growth performance. Thus, RBI have now adopted the policy of Growth with Stability. This means sufficient credit will be available for growing needs of different sectors of economy and at the same time, inflation will be controlled with in a certain limit. 2. Regulation, Supervision And Development Of Financial Stability :Financial stability means the ability of the economy to absorb shocks and maintain confidence in financial system. Threats to financial stability can come from internal and external shocks. Such shocks can destabilize the countrys financial system. Thus, greater importance is being given to RBIs role in maintaining confidence in financial system through proper regulation and controls, without sacrificing the objective of growth. Therefore, RBI is focusing on regulation, supervision and development of financial system. 3. Promoting Priority Sector :Priority sector includes agriculture, export and small scale enterprises and weaker section of population. RBI with the help of bank provides timely and adequately credit at affordable cost of weaker sections and low income groups.

RBI, along with NABARD, is focusing on microfinance through the promotion of Self Help groups and other institutions. 4. Generation Of Employment :Monetary policy helps in employment generation by influencing the rate of investment and allocation of investment among various economic activities of different labour Intensities. 5. External Stability :With the growth of imports and exports Indias linkages with global economy are getting stronger. Earlier, RBI controlled foreign exchange market by determining eaxchange rate. Now, RBI has only indirect control over external stability through the mechanism of managed Flexibility, where it influences exchange rate by buying and selling foreign currencies in open market. 6. Encouraging Savings And Investments :RBI by offering attractive interest rates encourage savings in the economy. A high rate of saving promotes investment. Thus the monetary management by influencing rates of interest can influence saving mobilization in the country. 7. Redistribution Of income And Wealth :- By control of inflation and deployment of credit to weaker sectors of society the monetary policy may redistribute income and wealth favouring to weaker sections. 8. Regulation Of NBFIs:Non Banking Financial Institutions (NBFIs), like UTI, IDBI, IFCI plays an important role in deployment of credit and mobilization of savings. RBI does not have any direct control on the functioning of such institutions. However it can indirectly affects the policies and functions of NBFIs through its monetary policy. Monetary policy of India Monetary policy is the process by which monetary authority of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth.[1] In India, the central monetary authority is the Reserve Bank of India (RBI). is so designed as to maintain the price stability in the economy. Other objectives of the monetary policy of India, as stated by RBI, are:

Price Stability Price Stability implies promoting economic development with considerable emphasis on price stability. The centre of focus is to facilitate the environment which is favourable to the architecture that enables the developmental projects to run swiftly while also maintaining reasonable price stability. Controlled Expansion Of Bank Credit One of the important functions of RBI is the controlled expansion of bank credit and money supply with special attention to seasonal requirement for credit without affecting the output. Promotion of Fixed Investment The aim here is to increase the productivity of investment by restraining non essential fixed investment. Restriction of Inventories Overfilling of stocks and products becoming outdated due to excess of stock often results is sickness of the unit. To avoid this problem the central monetary authority carries out this essential function of restricting the inventories. The main objective of this policy is to avoid over-stocking and idle money in the organization Promotion of Exports and Food Procurement Operations Monetary policy pays special attention in order to boost exports and facilitate the trade. It is an independent objective of monetary policy. Desired Distribution of Credit Monetary authority has control over the decisions regarding the allocation of credit to priority sector and small borrowers. This policy decides over the specified percentage of credit that is to be allocated to priority sector and small borrowers.

Equitable Distribution of Credit The policy of Reserve Bank aims equitable distribution to all sectors of the economy and all social and economic class of people To Promote Efficiency It is another essential aspect where the central banks pay a lot of attention. It tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc. Reducing the Rigidity RBI tries to bring about the flexibilities in the operations which provide a considerable autonomy. It encourages more competitive environment and diversification. It maintains its control over financial system whenever and wherever necessary to maintain the discipline and prudence in operations of the financial system.

The objectives of a monetary policy in India are similar to the objectives of its five year plans. In a nutshell planning in India aims at growth, stability and social justice. After the Keynesian revolution in economics, many people accepted significance of monetary policy in attaining following objectives. 1. 2. 3. 4. 5. 6. 7. Rapid Economic Growth Price Stability Exchange Rate Stability Balance of Payments (BOP) Equilibrium Full Employment Neutrality of Money Equal Income Distribution

These are the general objectives which every central bank of a nation tries to attain by employing certain tools (Instruments) of a monetary policy. In India, the RBI has always aimed at the controlled expansion of bank credit and money supply, with special attention to the seasonal needs of a credit. Let us now see objectives of monetary policy in detail :1. Rapid Economic Growth : It is the most important objective of a monetary policy. The monetary policy can influence economic growth by controlling real interest rate and its resultant impact on the investment. If the RBI opts for a cheap or easy credit policy by reducing interest rates, the investment level in the economy can be

encouraged. This increased investment can speed up economic growth. Faster economic growth is possible if the monetary policy succeeds in maintaining income and price stability. 2. Price Stability : All the economics suffer from inflation and deflation. It can also be called as Price Instability. Both inflation are harmful to the economy. Thus, the monetary policy having an objective of price stability tries to keep the value of money stable. It helps in reducing the income and wealth inequalities. When the economy suffers from recession the monetary policy should be an 'easy money policy' but when there is inflationary situation there should be a 'dear money policy'. 3. Exchange Rate Stability : Exchange rate is the price of a home currency expressed in terms of any foreign currency. If this exchange rate is very volatile leading to frequent ups and downs in the exchange rate, the international community might lose confidence in our economy. The monetary policy aims at maintaining the relative stability in the exchange rate. The RBI by altering the foreign exchange reserves tries to influence the demand for foreign exchange and tries to maintain the exchange rate stability. 4. Balance of Payments (BOP) Equilibrium : Many developing countries like India suffers from the Disequilibrium in the BOP. The Reserve Bank of India through its monetary policy tries to maintain equilibrium in the balance of payments. The BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. The former reflects an excess money supply in the domestic economy, while the later stands for stringency of money. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP equilibrium can be achieved. 5. Full Employment : The concept of full employment was much discussed after Keynes's publication of the "General Theory" in 1936. It refers to absence of involuntary unemployment. In simple words 'Full Employment' stands for a situation in which everybody who wants jobs get jobs. However it does not mean that there is a Zero unemployment. In that senses the full employment is never full. Monetary policy can be used for achieving full employment. If the monetary policy is expansionary then credit supply can be encouraged. It could help in creating more jobs in different sector of the economy. 6. Neutrality of Money : Economist such as Wicksted, Robertson have always considered money as a passive factor. According to them, money should play only a role of medium of exchange and not more than that. Therefore, the monetary policy should regulate the supply of money. The change in money supply creates monetary disequilibrium. Thus monetary policy has to regulate the supply of money and neutralize the effect of money expansion. However this objective of a monetary policy is always criticized on the ground that if money supply is kept constant then it would be difficult to attain price stability. 7. Equal Income Distribution : Many economists used to justify the role of the fiscal policy is maintaining economic equality. However in resent years economists have given the opinion that the monetary policy can help and play a supplementary role in attainting an economic equality. monetary policy can make special provisions for the neglect supply such as agriculture, small-scale industries, village industries, etc. and provide them with cheaper credit for longer term. This can prove fruitful for these sectors to come up. Thus in recent period, monetary policy can help in reducing economic inequalities among different sections of society.

Evaluation of the Monetary Policy in India During the reforms though the monetary policy has achieved higher success in the monetary policy, it is not free from limitation or demerits. It needs to be evaluated on a proper scale. 1. Failed in Tackling Budgetary Deficit: The higher level of the budget deficit has made the monetary policy ineffective. The automatic monetization of the deficit has led to high monetary expansion. 2. Limited Coverage: The Monetary policy covers only commercial banking system leaving other non-bank institutions untouched. It limits the effectiveness of the monitor policy in India. 3. Unorganized Money Market: In our country there is a huge size of the unorganized money market. It does not come under the control of the RBI. Thus any tools of the monetary policy does not affect the unorganized money market making monetary policy less affective. 4. Predominance of Cash Transaction: In India still there is huge dominance of the cash in total money supply. It is one of the main obstacles in the effective implementation of the Monetary policy. Because Monetary policy operates on the bank credit rather on cash. 5. Increase Volatility : As the Monetary policy has adopted changes in accordance to the changes in the external sector in India, it could lead to a high amount of the volatility.

EVALUATION OF MONETARY POLICY:The RBI aims at one time was controlled expansion. On one hand it was taking steps to expand bank credit. On other hand RBI uses quantitative and qualitative methods to control credit. These two contradictory objectives limited the success of monetary policy. The performance of monetary policy can be seen from its achievements and failures, let us discuss. I. 1. Achievements I Positive Aspects Of Monetary Policy :Short Term Liquidity Management :RBI has developed various methods to maintain stability in interest rate and exchange rate like LAF, OMO and MSS. RBI has also managed its sterlization operations very well.

2.

Financial Stability :With the help of controls, regulation and supervision mechanism, RBI has been successful in maintaining financial stability. During the period of global crisis it has also been able to maintain macro economic stability. 3. Financial Inclusion :Along with NABARD, RBI has made a great impact in the growth of microfinance. RBI has supported Self Help Group Model and promoted other microfinance institutions. 4. Adaptability:In India monetary policy is flexible, as it changes with time. RBI has developed new methods of credit control and shifted from monetary targeting to multiple indicator approach. 5. Increase In Growth:To maintain the growth of economy RBI has used its instruments' effectively. At present India has the second highest rate of GDP growth after China. Thus monetary policy has played an important role.

6. Increase In Bank Deposits:The increase in bank deposits over the years indicates trust and confidence of people in banking sector. Effective supervision of RBI over banks and financial institutions is largely responsible for trust and confidence of public in banking sector. 7. Competition Among Banks :The monetary policy of RBI has resulted in healthy competition among banks in the country. The competition is due to deregulation of interest rates and other measures taken by RBI. Now-a-days due to professionalism banks provide better service to customers.

II. 1.

FAILURES I LIMITATIONS OF MONETARY POLICY Huge Budgetary Deficits :RBI makes every possible attempt to control inflation and to balance money supply in the market. However Central Government's huge budgetary deficits have made monetary policy ineffective. Huge budgetary deficits have resulted in excessive monetary growth. Coverage Of Only Commercial Banks :-

2.

Instruments of monetary policy cover only commercial banks so inflationary pressures caused by banking finance can be controlled by RBI, but in India, inflation also results from deficit financing and scarcity of goods on which RBI may not have any control. 3. Problem Of Management Of Banks And Financial Institutions :The monetary policy can succeed to control inflation and to bring overall development only when the management of banks and Financial institutions are efficient and dedicated. Many officials of banks and financial institutions are corrupt and inefficient which leads to financial scams in this way overall economy is affected. Unorganised Money Market :Presence of unorganised sector of money market is one of the main obstacle in effective working of the monetary policy. As RBI has no power over the unorganised sector of money market, its monetary policy becomes less effective. Less Accountability:At present time, the goals of monetary policy in India, are not set out in specific terms and there is insufficient freedom in the use of instruments. In such a setting, accountability tends to be weak as there is lack of clarity in the responsibility of governments and RBI. Black Money :There is a growing presence of black money in the economy. Black money falls beyond the purview of banking control of RBI. It means large proposition of total money Supply in a country remains outside the purview of RBI's monetary management. Increase Volatility :The integration of domestic and foreign exchange markets could lead to increased volatility in the domestic market as the impact of exogenous factors could be transmitted to domestic market. The widening of foreign exchange market and development of rupee - foreign exchange swap would reduce risks and volatility. Lack of Transparency:According to S. S. Tara pore, the monetary policy formulation, in its present form in India, cannot be continued indefinitely. For a more effective policy, it would be necessary to have greater transparency in the policy formulation and transmission process and the RBI would need to be clearly demarcated.

4.

5.

6.

7.

8.

Types:In practice, to implement any type of monetary policy the main tool used is modifying the amount of base money in circulation. The monetary authority does this by buying or selling financial assets (usually government obligations). These open market operations change either the amount of money or its liquidity (if less liquid forms of money are bought or sold). The multiplier effect offractional reserve banking amplifies the effects of these actions. Constant market transactions by the monetary authority modify the supply of currency and this impacts other market variables such as short term interest rates and the exchange rate. The distinction between the various types of monetary policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals. Monetary Policy: Target Market Variable: Inflation Targeting Price Level Targeting Monetary Aggregates Fixed Exchange Rate Gold Standard Mixed Policy Interest rate on overnight debt Interest rate on overnight debt The growth in money supply The spot price of the currency The spot price of gold Usually interest rates Long Term Objective: A given rate of change in the CPI A specific CPI number A given rate of change in the CPI The spot price of the currency Low inflation as measured by the gold price Usually unemployment + CPI change

The different types of policy are also called monetary regimes, in parallel to exchange rate regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results in a relatively fixed regime towards the currency of

other countries on the gold standard and a floating regime towards those that are not. Targeting inflation, the price level or other monetary aggregates implies floating exchange rate unless the management of the relevant foreign currencies is tracking exactly the same variables (such as a harmonized consumer price index). In economics, an expansionary fiscal policy includes higher spending and tax cuts, that encourage economic growth.[26] In turn, an expansionary monetary policy is one that seeks to increase the size of the money supply. Conversely, contractionary monetary policy seeks to reduce the size of the money supply. In most nations, monetary policy is controlled by either a central bank or afinance ministry. In most nations, monetary policy is controlled by either a central bank or a finance ministry. Neoclassical and Keynesian economics significantly differ on the effects and effectiveness of monetary policy on influencing the real economy; there is no clear consensus on how monetary policy affects real economic variables (aggregate output or income, employment). Both economic schools accept that monetary policy affects monetary variables (price levels, interest rates). 1) Inflation targeting Under this policy approach the target is to keep inflation, under a particular definition such as Consumer Price Index, within a desired range. The inflation target is achieved through periodic adjustments to the Central Bank interest rate target. The interest rate used is generally the interbank rate at which banks lend to each other overnight for cash flow purposes. Depending on the country this particular interest rate might be called the cash rate or something similar. The interest rate target is maintained for a specific duration using open market operations. Typically the duration that the interest rate target is kept constant will vary between months and years. This interest rate target is usually reviewed on a monthly or quarterly basis by a policy committee. Changes to the interest rate target are made in response to various market indicators in an attempt to forecast economic trends and in so doing keep the market on track towards achieving the defined inflation target. For example, one simple method of inflation targeting called the Taylor rule adjusts the interest rate in response to changes in the inflation rate and the output gap. The rule was proposed by John B. Taylor of Stanford University.[27]

The inflation targeting approach to monetary policy approach was pioneered in New Zealand. It has been used in Australia, Brazil, Canada, Chile, Colombia, the Czech Republic, Hungary, New Zealand, Norway, Iceland, India, Philippines, Poland, Sweden, South Africa, Turkey, and the United Kingdom. 2) Price level targeting Price level targeting is a monetary policy that is similar to inflation targeting except that CPI growth in one year over or under the long term price level target is offset in subsequent years such that a targeted price-level is reached over time, e.g. five years, giving more certainty about future price increases to consumers. Under inflation targeting what happened in the immediate past years is not taken into account or adjusted for in the current and future years. Uncertainty in price levels can create uncertainty around price and wage setting activity for firms and workers, and undermines any information that can be gained from relative prices, as it is more difficult for firms to determine if a change in the price of a good or service is because of inflation or other factors, such as an increase in the efficiency of factors of production, if inflation is high andvolatile. An increase in inflation also leads to a decrease in the demand for money, as it reduces the incentive to hold money and increases transaction costs and shoe leather costs. 3) Monetary aggregates In the 1980s, several countries used an approach based on a constant growth in the money supply. This approach was refined to include different classes of money and credit (M0, M1 etc.). In the USA this approach to monetary policy was discontinued with the selection of Alan Greenspan as Fed Chairman. This approach is also sometimes called monetarism. While most monetary policy focuses on a price signal of one form or another, this approach is focused on monetary quantities. As these quantities could have a role on the economy and business cycles depending on the households' risk aversion level, money is sometimes explicitly added in the central bank's reaction function.[28]

4) Fixed exchange rate This policy is based on maintaining a fixed exchange rate with a foreign currency. There are varying degrees of fixed exchange rates, which can be ranked in relation to how rigid the fixed exchange rate is with the anchor nation. Under a system of fiat fixed rates, the local government or monetary authority declares a fixed exchange rate but does not actively buy or sell currency to maintain the rate. Instead, the rate is enforced by non-convertibility measures (e.g. capital controls, import/export licenses, etc.). In this case there is a black market exchange rate where the currency trades at its market/unofficial rate. Under a system of fixed exchange rates maintained by a currency board every unit of local currency must be backed by a unit of foreign currency (correcting for the exchange rate). This ensures that the local monetary base does not inflate without being backed by hard currency and eliminates any worries about a run on the local currency by those wishing to convert the local currency to the hard (anchor) currency. 5) Gold standard The gold standard is a system under which the price of the national currency is measured in units of gold bars and is kept constant by the government's promise to buy or sell gold at a fixed price in terms of the base currency. The gold standard might be regarded as a special case of "fixed exchange rate" policy, or as a special type of commodity price level targeting. Today this type of monetary policy is no longer used by any country, although the gold standard was widely used across the world between the mid-19th century through 1971.[29] Its major advantages were simplicity and transparency. The gold standard was abandoned during the Great Depression, as countries sought to reinvigorate their economies by increasing their money supply.[30] The Bretton Woods system, which was a modified gold standard, replaced it in the aftermath of World War II. However, this system too broke down during the Nixon shock of 1971. The gold standard induces deflation, as the economy usually grows faster than the supply of gold. When an economy grows faster than its money supply, the same amount of money is used to execute a larger number of transactions. The only way to make this possible is to lower the nominal cost of each transaction, which means that prices of goods and services fall, and each unit of money increases in value. Absent precautionary measures, deflation would tend to

increase the ratio of the real value of nominal debts to physical assets over time. For example, during deflation, nominal debt and the monthly nominal cost of a fixed-rate home mortgage stays the same, even while the dollar value of the house falls, and the value of the dollars required to pay the mortgage goes up. Economists generally consider such deflation to be a major disadvantage of the gold standard. Unsustainable (i.e. excessive) deflation can cause problems during recessions andfinancial crisis lengthening the amount of time an economy spends in recession. William Jennings Bryan rose to national prominence when he built his historic (though unsuccessful) 1896 presidential campaign around the argument that deflation caused by the gold standard made it harder for everyday citizens to start new businesses, expand their farms, or build new homes.[31]

8 Main Features of the Monetary Policy of the Reserve Bank of India The main features of the monetary policy of the Reserve Bank of India are given below: 1. Active Policy: Before the advent of planning in India in 1951, the monetary policy of the Reserve Bank was a passive, cheap and easy policy. It means that Reserve Bank did not use the measures of monetary policy to regulate the economy. For example from 1935 to 1951, the bank rate remained stable at 3%. But since 1951, the Reserve Bank has been following an active monetary policy. It has been using all the measures of credit control. 2. Overall Expansion: An important feature of Reserve Banks monetary policy is that of overall expansion of money supply. In the words of S.L.N. Sinha The Reserve Banks responsibility is not merely one of credit restriction. In a growing economy there has to be continuous expansion of money supply and bank credit and the central bank has the duty to see that legitimate credit requirements are met. In fact, the overall, trend of money supply has been one of the expansions along with an almost continuous rise in price level. 3. Seasonal Variations: The monetary policy is characterised by the changing behaviour of busy and slack seasons. These seasons are tied to the agricultural seasons. In the busy season there is an expansion of funds on account of the seasonal needs of financing production, and inventory building of agricultural commodities. On the other hand, the slack season is characterised by the contraction of funds due to the return flow. It may be pointed out that aggregate contraction of funds during the slack season has tended to fall far short of expansion in the preceding busy season. The main reason behind this changing pattern is the requirement of additional funds by the industrial sector. Thus, during busy season the Reserve Bank adopts

an expansionary credit policy and tightens the liquidity pressures during the slack season. 4. Tight and Dear Monetary Policy: In order to restrain inflation the Reserve Bank has often adopted a tight and dear monetary policy. A tight monetary policy implies that the rate of growth of money supply is lowered. A dear money policy refers to increase in bank rate. This increase in bank rate leads to an increase in the interest rates charged by the banks. 5. Investment and Saving Oriented: The monetary policy adopted by the Reserve Bank is both investment and saving oriented. To encourage investment, adequate funds were made available for productive purposes at reasonable rates of interest. The Reserve Bank has also kept the interest on deposits at a reasonable rate to attract savings. 6. Imbalance in Credit Allocation: The monetary policy is biased towards industrial sector. Agriculture does not get the required institutional finances. Consequently, it has to depend upon money lenders to a considerable extent for its credit needs. The agricultural sector has to pay high rate of interest and even then does not get required amount of capital. A large part of funds flows to large industries. Even small scale industries suffer from the inadequacy of finances. Thus monetary policy has resulted in imbalances in credit allocation. 7. Wide Range of Methods of Credit Control: The Reserve Bank has used a wide range of instruments of credit control. It has adopted all the measures of quantitative and qualitative credit controls to meet the needs of a complex and varying economic situation. Since the objective has been to achieve economic growth with stability, the policy of monetary management has gone beyond the traditional regulatory function. It has adopted a more positive role of channeling credit to desired sectors. 8. Guiding Factors: According to Shri. C. Rangarajan the following three factors have essentially guided the conduct of monetary policy:

(i) Monetary policy measures have generally been a response to fiscal policy. (ii) While monetary policy has been primarily acting through availability of credit, the cost of credit has also been adjusted upwards sometimes very sharply to meet effectively the inflationary situations. (iii) The areas of operation of monetary policy did not remain confined to those related to regulation of monetary authority in the allocation of credit to the nonGovernment sector because of an important element of national economic policy, specially after the nationalisation of banks.