Thus tight monetary policy failed to check inflation despite 3.75 percentage points increase in repo rate. It was estimated at 10 per cent (YoY) in September 2011, 9.73% in October 2011 and 9.11 per cent in November 2011. Prior to 2008, when the prices of houses were rising the Americans had made excessive investment in houses financed by sub-prime housing loans given on a large scale by the American banks at low rates of interests.

Furthermore, the policy of selective credit controls is especially suited to the needs of underdeveloped countries where the orthodox monetary techniques have limited applicability. (1) By borrowing by issuing bonds (which are generally purchased by banks, insurance companies, mutual funds, pension funds etc.) This can happen when the banks may have surplus liquidity (i.e., cash reserves) with them and therefore they may not follow tight monetary policy and raise their lending rates. Several monetary measures can be adopted to raise the aggregate rate of saving. However, with financial reforms this is no more the situation. Both large-scale and medium industries require funds for investment in fixed capital, working capital and for maintaining inventories. Besides, the RBI blamed supply-side factors responsible for food inflation which has contributed to overall rise in WPI inflation. This led the Finance Minister, Mr. Chidambaram, in his budget for 2013-14 to announce issuing of inflation-indexed bonds on which nominal interest rate will automatically rise with the increase in inflation rate. Repo rate is the interest rate at which Reserve Bank of India lends funds to the commercial banks for a short period. Following the soft-interest rate policy of Reserve Bank of India prime lending rates of interest of commercial banks, which varied between 15 and 16 per cent prior to 1996, were reduced over a period of time to 9 to 10 per cent in 2003.

At present RBI often uses open market operations to influence liquidity of the banking system. For this, a good part of bank deposits mobilised by the banks should be invested in Government and other approved securities so that the government should be able to finance its planned investment, especially in infrastructure. Thirdly, when the stock market prices are rising and aggregate demand is quite high, the corporate sector is able to raise funds itself more easily from the capital market. A low level of inflation is considered to be healthy for the economy. The increase in the supply of money by the monetary authority will cause the market rate of interest to fall. They greatly widen the horizons of development along predetermined and desired directions. In particular, we describe several structural transformations that were difficult to discern in real time, including a diminished sensitivity of inflation to resour ce slack, a decline in the natural rate of unemployment, and a decline in the neutral federal funds rate ( r*). First, monetary transmission mechanism may be weak and raising of short-term interest rates by the RBI may not actually lead to the restriction of bank credit. It is noteworthy that a recent monetary theory emphasizes that it is changes in the credit availability rather than cost of credit (i. e., rate of interest) that is a more effective instrument of regulating aggregate demand. With more bank branches in under-banked and underdeveloped regions, the people who consume away their surplus incomes will be induced to save them in the form of bank deposits which are quite safe as a store of value. Another instrument with Reserve Bank of India for affecting credit availability is the statutory liquidity ratio. The developing economies must strive for an extension of credit planning over wider areas. The interest rates were then so low that the conventional monetary policy of lowering interest rates had lost its ability to stimulate the economy. The RBI can reduce the liquidity with the banks by selling government securities to them through open market operations. Growth of these and such other unproductive activities can be held in check by raising the margin requirements for the blackballed collaterals. First, a high interest rate policy can promote savings. But to tap and raise savings sufficiently and to prevent its unproductive use, banks and other financial institutions need to be numerous and dispersed throughout the economy in both the urban and rural areas. Find out about our monetary policy framework and central bank operations, and access our statements, reports and models.

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