Monetary Policy Making: Challenges in an Open Economy

Abstract

Whether Central Bank should habitually intervene or should not intervene at all with the exchange rate movements is a burgeoning question. If we accept intervention, the question arises as to what should be the extent of Reserve Bank of India's intervention to contain the expansionary impact of global capital inflows? The ramifications of 'RBI's intervention' has given rise to many complexities which need exploration. This will help to delineate the possible mechanisms to overcome the trade-off between the various objectives of monetary policy. Indian experience reveals that the large inflows of foreign capital put upward pressure on exchange rate; monetary expansion resulting from intervention tends to exert upward pressure on domestic price level. This raises the issue of an appropriate exchange rate policy and price policy. There is, thus, an imperative to study the various monetary policy instruments, goals and policy variables in the wake of the changed scenario. The research paper inter alia would focus on the following: · Reasons involved towards changing character of 'reserve money'; · Emerging challenges in terms of 'exchange rate management' and 'domestic price stability'; · An analysis of the efficacy of the existing instruments used to tackle the challenges; · To suggest alternative policy options for tackling challenges.