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RBI AND ITS REGULATORY MECHANISM

The Reserve Bank of India (RBI) is India's central banking institution, which controls themonetary policy of

the Indian rupee. It was established on 1 April 1935 during the British Raj in accordance with the provisions ofthe Reserve Bank of India Act, 1934. The share capital was divided into shares of 100 each fully paid which

was entirely owned by private shareholders in the beginning. Following India's independence in 1947, the RBIwas nationalised 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 Duvvuri Subbarao), four DeputyGovernors, two Finance Ministry representative, ten Government-nominated 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 consist of five members who represent regional

interests, as well as the interests of co-operative and indigenous banks.

The bank is also active in promoting financial inclusion policy and is a leading member of the Alliance for

Financial Inclusion (AFI). View the bank on AFI's member map or readRBI financial inclusion-related news.

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 came into picture according to the guidelines laid down by Dr. Ambedkar. RBI was conceptualized asper the guidelines, working style and outlook presented by Dr Ambedkar in front of the Hilton YoungCommission. 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 Dr Ambedkars book named The

Problem of the Rupee Its origin and its solution. [4] The Bank was set up based on the recommendations ofthe 1926 Royal Commission on Indian Currency and Finance, also known as the HiltonYoung Commission

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 securemonetary 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

.
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moved to Bombay (now Mumbai) in 1937. The RBI also acted as Burma's central bank, except during the years

of theJapanese occupation of Burma (194245), until April 1947, even though Burma seceded from the IndianUnion 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 theGovernment of Indiasince its nationalization in 1949.

19501960

In the 1950s, the Indian government, under its first Prime MinisterJawaharlal Nehru, developed a centrallyplanned economic policy that focused on the agricultural sector. The administration nationalized commercial

banks 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.

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 Indiangovernment 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 toplay 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. The regulation of the economy and especially the

financial sector was reinforced by the Government of India in the 1970s and 1980s. The central bank became

the central player and increased its policies for a lot of tasks like interests, reserve ratio and visible deposits.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.

The branch was forced to establish two new offices in the country for every newly established office in a town.The oil crises in 1973 resulted in increasing inflation, and the RBI restricted monetary policy to reduce the

effects.

19851991

A lot of committees analyses 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 DevelopmentResearch 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" (Mackinnonand Shaw).[14]TheDiscount and Finance House of India began its operations on the monetary market in Apri

1988; theNational 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 liberalization.

19912000

The national economy came down in July 1991 and the Indian rupee was devalued. 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-
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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 liberalizationto diversify owner structures in 1998.

TheNational 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

companytheBharatiya Reserve Bank Note Mudran Limitedin February 1995 to produce banknotes.[20]

Since 2000

TheForeign Exchange Management Actfrom 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 in20042005 (National Electronic Fund Transfer). The Security Printing & Minting Corporation of India Ltd., a

merger of nine institutions, was founded in 2006 and produces banknotes and coins.

The national economy's growth rate came down to 5.8% in the last quarter of 20082009 and the central bank

promotes the economic development.

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 torepresent 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. The Central Government hasnominated 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.

Governors

The current Governor of RBI is Duvvuri Subbarao. The RBI extended the period of the present governor up to2013. There are four deputy governors, Deputy GovernorK C Chakrabarty, Urjit Patel, Shri Anand Sinhaand Shri 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.

Supportive bodies
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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 thecentral 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.

TheBoard of Financial Supervision (BFS), formed in November 1994, serves as a CCBD committee to contro

the financial institutions. It has four members, appointed for two years, and takes measures to strength the roleof 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 committeerecommended 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 4 zonal offices. 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, ChandigarhChennai, Delhi, Guwahati, Hyderabad, Jaipur, Jammu, Kanpur, Kolkata, Lucknow, Mumbai, Nagpur, Patna

and Thiruvananthapuram. Besides it has 09 sub-offices at Agartala,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 fourZonal Training Centers at Mumbai,Chennai, Kolkata and

New Delhi.

Main functions

Reserve Bank of India regional office, Delhi entrance with the Yakshini sculpture depicting "Prosperity through

agriculture".
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The RBI Regional Office in Delhi.

The regional offices ofGPO (in white) and RBI (in sandstone) at Dalhousie Square,Kolkata.

Bank of Issue

Under Section 22 of the Reserve Bank of India Act, the Bank has the sole right to issue bank notes of alldenominations. 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.

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 aswell as it has to ensure an adequate flow of credit to productive sectors.

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 tomaintain public confidence in the system, protect depositors' interest and provide cost-effective bankingservices 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 rupeebanknotes as well as coins.

Managerial of exchange control
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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 exchangemarket in India.

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 commercia

banks to maintain or improve the GDP. The basic objectives of RBI are to issue bank notes, to maintain thecurrency 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 aseconomic development, because both objectives are diverse in themselves.

Banker of Banks

Nagpurbranch holds most of India's gold deposits

RBI also works as a central bank where commercial banks are account holders and can deposit money.RBImaintains banking accounts of all scheduled banks. 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 emergencyadvances to the banks. It supervises the functioning of the commercial banks and take action against it if need

arises.

Detection of fake currency

In order to curb the fake currency menace, RBI has launched a website to raise awareness among masses aboufake notes in the market.www.paisaboltahai.rbi.org.inprovides information about identifying fake currency.

Developmental role

The central bank has to perform a wide range of promotional functions to support national objectives andindustries. The RBI faces a lot of inter-sectoral and local inflation-related problems. Some of this problems areresults of the dominant part of the public sector

Related functions

The RBI is also a banker to the government and performs merchant banking function for the central and the

state governments. It also acts as their banker. The National Housing Bank(NHB) was established in 1988 to

promote private real estate acquisition. The institution maintains banking accounts of all scheduled banks, too
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RBI on 7 August 2012 said that Indian banking system is resilient enough to face the stress caused by the

drought like situation because of poor monsoon this year.

Policy rates and reserve ratios

Policy rates, Reserve ratios, lending, and deposit rates as of 30, October, 2012

Bank Rate 7.75%(29/1/2013)

Repo Rate 7.75%

Reverse Repo Rate 6.75%

Cash Reserve Ratio (CRR) 4%

Statutory Liquidity Ratio (SLR) 23.0%

Base Rate 9.75%10.50%

Reserve Bank Rate 4%

Deposit Rate 8.50%9.00%

Bank Rate

RBI lends to the commercial banks through its discount window to help the banks meet depositors demands

and reserve requirements for long term. The Interest rate the RBI charges the banks for this purpose is calledbank rate. If the RBI wants to increase the liquidity and money supply in the market, it will decrease the bank

rate and if RBI wants to reduce the liquidity and money supply in the system, it will increase the bank rate. As

of 25 June 2012 the bank rate was 8.0%.latest bank rate is 7.75% as on 29/01/2013.

Reserve requirement cash reserve ratio (CRR)

Every commercial bank has to keep certain minimum cash reserves with RBI. Consequent upon amendment tosub-Section 42(1), the Reserve Bank, having regard to the needs of securing the monetary stability in the

country, RBI can prescribe Cash Reserve Ratio (CRR) for scheduled banks without any floor rate or ceiling

rate, [Before the enactment of this amendment, in terms ofSection 42(1) of the RBI Act, the Reserve Bank

could prescribe CRR for scheduled banks between 5% and 20% of total of their demand and time liabilities]RBI uses this tool to increase or decrease the reserve requirement depending on whether it wants to effect a

decrease or an increase in the money supply. An increase in Cash Reserve Ratio (CRR) will make it mandatoryon the part of the banks to hold a large proportion of their deposits in the form of deposits with the RBI. This

will reduce the size of their deposits and they will lend less. This will in turn decrease the money supply. The

current rate is 4.75%. ( As a Reduction in CRR by 0.25% as on Date- 17 September 2012). -25 basis points cut

in Cash Reserve Ratio (CRR) on 17 September 2012. It will release Rs 17,000 crore into the system/Market.The RBI lowered the CRR by 25 basis points to 4.25% on 30 October 2012, a move it said would inject about

175 billion rupees into the banking system in order to pre-empt potentially tightening liquidity. The latest CRR

as on 29/01/13 is 4%

Statutory Liquidity ratio (SLR)

Apart from the CRR, banks are required to maintain liquid assets in the form of gold, cash and approved

securities. Higher liquidity ratio forces commercial banks to maintain a larger proportion of their resources in

liquid form and thus reduces their capacity to grant loans and advances, thus it is an anti-inflationary impact. Ahigher liquidity ratio diverts the bank funds from loans and advances to investment in government and approved

securities.

In well-developed economies, central banks use open market operationsbuying and selling of eligible

securities by central bank in the money marketto influence the volume of cash reserves with commercialbanks and thus influence the volume of loans and advances they can make to the commercial and industrial


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sectors. In the open money market, government securities are traded at market related rates of interest. The RBI

is resorting more to open market operations in the more recent years.

Generally RBI uses three kinds of selective credit controls:

1. Minimum margins for lending against specific securities.

2. Ceiling on the amounts of credit for certain purposes.

3. Discriminatory rate of interest charged on certain types of advances.

Direct credit controls in India are of three types:

1. Part of the interest rate structure i.e. on small savings and provident funds, are administratively set.

2. Banks are mandatory required to keep 23% of their deposits in the form of government securities.

3. Banks are required to lend to the priority sectors to the extent of 40% of their advances

MONETARY POLICY

MEANING OF MONETRAY POLICY

Monetary policy is the process by which the monetary authorityof a country controls the supply of

money, often targeting a rate ofinterest to attain a set of objectives oriented towards the growth and stability ofthe economy. These goals usually include stable prices and low unemployment. Monetary theoryprovides

insight into how to craft optimal monetary policy. Monetary policy rests on the relationship between the rates of

interest in an economy, that is the price at which money can be borrowed, and the total supply of money.

Monetary policy is referred to as either being an expansionary policy, or a contractionary policy

where an expansionary policy increases the total supply of money in the economy rapidly, and a contractionarypolicy decreases the total money supply or increases it only slowly. Expansionary policy is traditionally used to

combat unemployment in a recession by lowering interest rates, while contractionary policy involves raisinginterest rates to combatinflation. Monetary policy is contrasted with fiscal policy, which refers to government

borrowing, spending and taxation.

A policy is referred to as contractionary if it reduces the size of the money supply or increases it only

slowly, or if it raises the interest rate. An expansionary policy increases the size of the money supply morerapidly, or decreases the interest rate. Furthermore, monetary policies are described as follows: accommodative,

if the interest rate set by the central monetary authority is intended to create economic growth; neutral, if it is

intended neither to create growth nor combat inflation; or tight if intended to reduce inflation.

Monetary policy is the process by which the government, central bank, or monetary authority of a countrycontrols (i) the supply of money, (ii) availability of money, and (iii) cost of money or rate of interest to attain a

set of objectives oriented towards the growth and stability of the economy. Monetary theory provides insight

into how to craft optimal monetary policy.

OBJECTIVES OF MONETARY POLICY
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The main objectives of monetary policy are:

Price stability

Exchange stability

Full employment and maximum growth

High rate of growth.

The objectives are to maintain price stability and ensure adequate flow of credit to the productive sectors of the

economy. Stability for the national currency (after looking at prevailing economic conditions), growth in

employment and income are also looked into. The monetary policy affects the real sector through long and

variable periods while the financial markets are also impacted through short-term implications.

There are four main 'channels' which the RBI looks at:

Quantum channel: money supply and credit (affects real output and price level through changes in

reserves money, money supply and credit aggregates).

Interest rate channel.

Exchange rate channel (linked to the currency).

Asset price

TOOLS OF MONETARY POLICY

Monetary policy tools

Monetary base

Reserve requirements

Discount window lending

Interest rates

Currency board

Unconventional monetary policy at the zero bound

Monetary base

Monetary policy can be implemented by changing the size of the monetary base. This directly changes the total

amount of money circulating in the economy. A central bank can use open market operations to change the

monetary base. The central bank would buy/sellbonds in exchange for hard currency. When the central bank

disburses/collects this hard currency payment, it alters the amount of currency in the economy, thus altering the

monetary base.
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Reserve requirements

The monetary authority exerts regulatory control over banks. Monetary policy can be implemented by changing

the proportion of total assets that banks must hold in reserve with the central bank. Banks only maintain a small

portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like

mortgages and loans. By changing the proportion of total assets to be held as liquid cash, the Federal Reserve

changes the availability of loanable funds. This acts as a change in the money supply. Central banks typically do

not change the reserve requirements often because it creates very volatile changes in the money supply due to

the lending multiplier.

Discount window lending

Discount window lending is where the commercial banks, and other depository institutions, are able to borrow

reserves from the Central Bank at a discount rate. This rate is usually set below short term market rates (T-

bills). This enables the institutions to vary credit conditions (i.e., the amount of money they have to loan out),

there by affecting the money supply. It is of note that the Discount Window is the only instrument which the

Central Banks do not have total control over.

By affecting the money supply, it is theorized, that monetary policy can establish ranges for inflation,

unemployment, interest rates, and economic growth. A stable financial environment is created in which savings

and investment can occur, allowing for the growth of the economy as a whole.

Interest rates

The contraction of the monetary supply can be achieved indirectly by increasing the nominal interest rates.

Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the

United States, the Federal Reserve can set the discount rate, as well as achieve the desiredFederal funds

rate by open market operations. This rate has significant effect on other market interest rates, but there is no

perfect relationship. In the United States open market operations are a relatively small part of the total volume

in the bond market. One cannot set independent targets for both the monetary base and the interest rate because

they are both modified by a single tool open market operations; one must choose which one to control.

In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings

accounts or other financial assets. By raising the interest rate(s) under its control, a monetary authority can

contract the money supply, because higher interest rates encourage savings and discourage borrowing. Both of

these effects reduce the size of the money supply.

Currency board

A currency board is a monetary arrangement that pegs the monetary base of one country to another, the anchor

nation. As such, it essentially operates as a hard fixed exchange rate, whereby local currency in circulation is

backed by foreign currency from the anchor nation at a fixed rate. Thus, to grow the local monetary base an

equivalent amount of foreign currency must be held in reserves with the currency board. This limits the
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possibility for the local monetary authority to inflate or pursue other objectives. The principal rationales behind

a currency board are threefold:

1. To import monetary credibility of the anchor nation;

2. To maintain a fixed exchange rate with the anchor nation;

3. To establish credibility with the exchange rate (the currency board arrangement is the hardest

form of fixed exchange rates outside of dollarization).

In theory, it is possible that a country may peg the local currency to more than one foreign currency; although,

in practice this has never happened (and it would be a more complicated to run than a simple single-currency

currency board). A gold standard is a special case of a currency board where the value of the national currency

is linked to the value of gold instead of a foreign currency.

The currency board in question will no longer issue fiat money but instead will only issue a set number of units

of local currency for each unit of foreign currency it has in its vault. The surplus on thebalance of payments of

that country is reflected by higherdeposits local banks hold at the central bank as well as (initially) higherdeposits of the (net) exporting firms at their local banks. The growth of the domesticmoney supplycan now be

coupled to the additional deposits of the banks at the central bank that equals additional hard foreign exchange

reservesin the hands of the central bank. The virtue of this system is that questions of currency stability no

longer apply. The drawbacks are that the country no longer has the ability to set monetary policy according to

other domestic considerations, and that the fixed exchange rate will, to a large extent, also fix a country's terms

of trade, irrespective of economic differences between it and its trading partners.

Currency boards have advantages for small, open economies that would find independent monetary policy

difficult to sustain. They can also form acredible commitment to low inflation.

Unconventional monetary policy at the zero bound

Other forms of monetary policy, particularly used when interest rates are at or near 0% and there are concerns

about deflation or deflation is occurring, are referred to as unconventional monetary policy. These

include credit easing,quantitative easing, and signaling. In credit easing, a central bank purchases private sector

assets, in order to improve liquidity and improve access to credit. Signaling can be used to lower market

expectations for future interest rates. For example, during the credit crisis of 2008, the US Federal Reserve

indicated rates would be low for an extended period, and the Bank of Canada made a conditional

commitment to keep rates at the lower bound of 25 basis points (0.25%) until the end of the second quarter of

2010.
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ROLE AND BENEFITS OF MONETARY POLICY IN INDIA

The role of monetary policy

A summary of the role that monetary policy plays is provided in this quote from the Government of the Bank of

England, Mervyn King.

The role of monetary policy the Governors views

what is the mechanism by which monetary policy contributes to a more stable economy? I would argue thatmonetary policy is now more systematic and predictable than before. Inflation expectations are anchored to the

2% target. Businesses and families expect that monetary policy will react to offset shocks that are likely to drive

inflation away from target. In the jargon of economists, the policy reaction function of the Bank of England is

more stable and predictable than was the case before inflation targeting, and easier to understand. More simply,monetary policy is not adding to the volatility of the economy in a way that it did in earlier decades.

Adapted from The Inflation Target Ten Years on, Mervyn King in October 2002

Monetary Policy and the Exchange Rate

There is no official exchange rate target for the British economy. The UK operates within a floating exchangeratesystem and has done ever since we suspended our membership of the European exchange rate mechanism

(the ERM) in September 1992. The Monetary Policy Committee has occasionally discussed the relative merits

and de-merits of intervening in the current markets to influence the external value of the pound but no officialintervention has occurred for over a decade. There are in any case doubts about the effectiveness of direct

intervention in the foreign exchange markets as a means of achieving a desired exchange rate.

Monetary policy and the money supply

There are currently no targets for the growth of the money supply measured by MO and M4. Data on the

growth of the stock of money provides useful information for the MPC on the strength of aggregate demand butinterest rates are not determined with reference to specific targets for the money supply. In addition the UK no

longer imposes supply-side controls on the growth of bank lending and consumer credit. Instead monetary

policy in the UK is designed to control the growth in the demand for money through changing the cost of loansand influencing the incentive to save via changes in interest rates.

Fundamentals of Monetary Policy:

Monetary policy rests on the idea that to expand the economy, one must increase the money supply. This

is done by either printing more money, lending more money to banks, lowering the interest rate to

encourage borrowing and discourage savings, and by the central bank buying bonds from the

market and paying with cash, which enters the economy. To slow or contract the economy, the

opposite approach is pursued.

Advantages of Monetary Policy:

Inflation: Monetary policy, though often strongest when used in coordination with fiscal policy, has

several advantages to fiscal policy. For one, fiscal policy has a tendency to cause massive inflation.

Government infusion of money into the economy through spending can cause massive increases in

inflation. To slow inflation, it is hard to cut spending and raise taxes politically, thereby contracting
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the economy, and thus it rarely works as an effective way to contract the economy. Monetary

policy, by contrast, can cause inflation, but raising and lowering interest rates, and increasing and

decreasing the money supply tend to be effective ways of economic control that aren't excessively

inflationary.

Speed of Results: The speed that policies enacted produce results is another contrast. Fiscal policy is

slowly enacted. Congress must debate legislation, and any action may take months to pass through

Congress and be signed intolaw. Monetary policy, however, can be acted on immediately to

respond quickly to economic circumstances. Monetary policy is primarily controlled by economistswhile fiscal policy is often subject to politics .
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