Review of Applied Economics, Vol. 2, No. 2, (2006) : 181-199 * National Council of Applied Economic Research (NCAER), Parisila Bhawan, 11 Indra Prastha Estate, New Delhi-110 002, E-mail: ksingh@ncaer.org ** GRIPS-FASID Joint Graduate Program, GRIPS, 7-22-1 Roppongi, Tokyo, Japan, E-mail: kalirajan@grips.ac.jp MONETARY POLICY IN INDIA: OBJECTIVES, REACTION FUNCTION AND POLICY EFFECTIVENESS Kanhaiya Singh * & Kaliappa Kalirajan ** In the first part of this paper, the policy reaction functions of the Reserve Bank of India (RBI) have been modeled to see how policy stance decisions respond to the changes in the goal variables. In the second part, the transmission effects of RBIs policy stances on the goal variables have been analyzed using the Granger causality test, and analysis of simple estimated models of relevant variables. It may be suggested from the results that the RBI should not be working simultaneously with instruments of quantity and price control and should shelve the cash reserve ratio (CRR) and concentrate more on price variables for conducting monetary policy. JEL Classifications: C2; E4; E5 Keywords: Monetary policy; Granger block non-causality; India INTRODUCTION It is evident from the recent theoretical literature and empirical findings that monetary policy is best suited to achieving the goal of price stability in any economy (McCallum (1989)). Therefore, the consensus is that the key (or even the only) objective of monetary policy framework is to achieve long-term price stability (low and stable inflation) (BIS, 1998; Svensson, 2000; Bernanke et al., 1999). It has also been recognized that, in the long run, the objective of price stability and economic growth need not necessarily conflict with each other. It is argued that the desired effects on goal variables can be obtained by having a clear choice of objectives and policy instruments and right strategic implementation of policy stances. However, in the context of developing economy the role of monetary policy become more complex than the developed economies because of the supply constraints, underdeveloped financial market, and resource gap. The policy has to address multiple objectives of achieving and managing higher growth rate, while building potential to sustain growth and ensure macroeconomic stability for equitable development. While growth is important, rising prices hurt the poorest the most.