Monetary policy is all about balancing the desirable and the feasible.
Ensuring macroeconomic stability as reflected in low and stable prices is its biggest contribution to strong, sustainable and inclusive growth in India.
Its main objective is to ensure that an economy grows steadily along a path in which all available resources such as labour and capital are gainfully employed, or in other words, along its potential.
When the economy grows at a faster pace, it tends to overheat. Demand races ahead of supply, prices rise much more than people can tolerate, financial markets go through large fluctuations.
In these conditions, the task of monetary policy is to cool down the economy.
On the other hand, when an economy is falling below potential, problems like unemployment, unusually low and un-remunerative prices, depressed financial activity, and deficiency in resource use develop.
In such a situation, monetary policy has to boost the economy and revive it so that it returns to its potential.
MP can achieve its goal by changing the availability of money — in times of overheating, it reduces the supply of money while in times of depressed activity, and it expands money supply. It can also achieve the same result by changing the cost of money, which is the interest rate.
India has joined 40 other countries in implementing FIT, and significantly, there has not been a single back slide in the country experience. CPI inflation between September 2016 and March 2020 has averaged 4.2 percent.
With the Covid- 19 pandemic, however, supply disruptions and panic mark-ups have caused inflation to deviate substantially and breach the upper tolerance band since June 2020.
There is also evidence that the volatility of inflation or its variability came down during the new framework’s operation. This period also came to be associated with sizable capital inflows from abroad, indicating robust investor optimism, and a strong external position of the country.