Economic, Monetary and Fiscal Policies

8/22/2019 Economic, Monetary and Fiscal Policies

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Economic, Monetary and Fiscal Polic


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The key role of government is to create appropriate p

that promote economic growth.

Economic growth is stimulated by government policie

encourage investment, foster technology, provide key

and create a capable workforce through education an

training.

This the government achieves through its economic p

mainly monetary policy and fiscal policy.


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The objectives of economic policy are :

1. achieve faster economic growth

2. reduction in inequalities of income and wealth.

3. full employment.

4. price stability.

5. balance of payments equilibrium


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Monetary Policy

Monetary policy is primarily concerned with the man

of supply of money in an economy and managing the

growth of money supply per period.

It is the process by which the government controls th

availability and cost of money.

It uses the instruments within the control of the Cent

to influence the level of aggregate demand for goods

services .


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The modern economy is regarded as a credit econom

credit forms the basis of most of economic activities

economy.

Therefore, monetary policy operates through varying

and availability of credit.

These variations affect the demand for and supply of

the economy and the level and nature of economic a


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In India, the monetary policy statement is announced

year, through which the RBI seeks to ensure a price st

the economy.

However, the RBI reserves its right to alter it from tim


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Objectives of Monetary Policy

1. Safeguarding the countrys gold and forex reserves

2. Price stability.

3. Foreign exchange stability.

4. Managing cyclical fluctuations and adopting suitabstabilization measures.

5. Ensuring full employment.

6. Ensuring balance of payments equilibrium.

7. Accelerating economic growth


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Functions of Monetary Policy

The various functions of monetary policy are to ensure:

1. a most suitable interest structure 2. a correct balance between the demand and supply of

3. the provision of adequate credit facilities for a growing

4. keeping the inflation in check

5. overseeing of channeling of credit to users as per pre pinvestment decisions.

6. the establishment, functioning and growth of financiainstitutions.

7. proper management of public debt.


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Instruments of Monetary Policy

The monetary authority uses various tools to control the

money. These are known as the instruments of credit con

These instruments are of two types Quantitative and q

The quantitative instruments are bank rate policy, open

operation and changes in statutory reserve requirements

The qualitative instruments also known as selective cred

are credit rationing, direct action, changes in margin req

moral suasion.


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Quantitative Instruments

Bank Rate Policy: Bank rate is the minimum rate at w

central bank provides loans to other commercial ban

When the Central bank increases the bank rate, the o

fund from the central bank becomes costlier for othe

As a result other interest rates rise and borrowing be

costlier, thus contracting the credit in the economy.

The reverse happens when the bank rate is decreased


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Open Market Operations: This refers to the purchase and

government and other approved securities by the centra

It is primarily a tool of controlling the amount of money

circulation by buying and selling securities, foreign currecommodity.

All these purchase and sales result in the base currency eleaving market circulation.

When the central bank wants to withdraw money from c

it sells the securities and when it wants to increase the amoney in circulation, it buys these securities.


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Cash Reserve Requirement: The cash reserve ratio is

portion of a banks total cash reserves which they are

statutorily required to hold with the RBI.

An increase in CRR reduces the cash available for the

lending. Therefore it reduces the credit availability in

economy.


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Statutory Liquidity Ratio: Commercial banks are statu

required to hold a proportion of their liabilities in the

investment in government and other approved secur

This instrument is also used to control the supply of m

The main purpose of this instrument is to allocate ba

between government and commercial sectors.


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Qualitative Controls

Consumer Credit Regulation: Under this system when

there is inflationary pressure, the RBI can advise the

commercial banks to regulate terms and conditions o

extended to consumers for purchase of unnecessary

vehicles and electronic goods.

RBI can prescribe limits for amount of credit as well afor repayment.

These regulations are eased in times of recession.


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Direct Action: These may be a set of coercive measur

denial of discounting facilities against erring banks, ch

penal rate of interest and fixing quantitative ceiling o

Altering Margin Requirements: This measure is used

speculative activities.

The RBI has power to raise margin requirements for t

hoarding essential goods.


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Moral Suasion: The RBI has the authority to issue lice

new banks, to audit its accounts and order closure w

goes astray.

This authority it uses to exhort the banks to fall in lin

voluntarily.

In a market driven economy, it is this moral suasion r

formal monetary control that prompt financial institu

follow the directions of RBI.


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Rationing of Consumer credit: This measure is used t

that credit flows to the preferred sectors.

Under this measure the RBI may fix the maximum am

credit that can be extended by banks.

This measure is known as variable portfolio ceiling.


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Control Through Directives:

Differential rate of interest.


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Fiscal Policy

Fiscal policy plays an important role on the economic

social front of a country.

It is concerned with the state income and expenditur

Of late, because of the need to attain rapid economic

fiscal policy has been given a lot of importance and o

things like public borrowing, and deficit financing has

included in it.


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An effective fiscal policy is composed of policy decisio

relating to the financial structure of the government

includes such things as taxes, public expenditure, loa

transfer funds, budgetary deficit.

Harvey and Johnson have defined fiscal policy as ch

government expenditure and taxation designed to inthe pattern and level of activity.


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Objectives of the Fiscal Policy

Following are some of the important objectives of th

policy of Government of India:

1. To mobilise adequate resources for financing vario

programmes and projects adopted for economic dev

2.To raise the rate of savings and investment for incre

rate of capital formation.


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3. To promote development in the private sector through

incentive. 4. To arrange an optimum utilization of resources.

5. To control the inflationary pressures in economy in ordattain economic stability.

6. To remove poverty and unemployment.

7. To attain growth of public sector for attaining the objesocialistic pattern of society.

8. To reduce regional disparities.

9. To reduce the inequality in distribution of income and


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Techniques of fiscal policy in India

Following are the four main techniques of fiscal polic

1. Taxation Policy

2. Public expenditure policy.

3. public debt policy

4. Deficit financing policy.


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Taxation Policy

Taxation is one of the most important sources of reve

Govt. of India.

Both direct and indirect taxes are levied by the Gover

Taxes contribute almost 72% of the total revenue of t

government.


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The objectives of the taxation policy are :

- mobilization of resources

- formation of capital by promoting savings and inves

- attainment of equality of distribution of income and

- attainment of price stability by adopting anti inflatiotaxation policy.


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Public Expenditure Policy

Public expenditure plays an important role in the eco

development.

Since the government actively participates in the eco

activity, the volume of public expenditure is very high

Public or government expenditure may be developm

the development of infrastructure, health, education

developmental maintenance of law and order, defe


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Some of the important features of public expenditure

Development of infrastructure,

Development of public enterprise

Support to private sector

Social welfare and employment programmes.


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Policy of deficit financing

Deficit financing indicates loan taking by the governm

RBI in the form of issuing fresh dose of currency.

In order to bridge the gap between Income and expe

when the government asks the RBI to print currency

is called deficit financing.

It is a form of forced saving which result due to increa

prices during the period of government investment.


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Thus deficit financing helps the government by provi

necessary funding for economic growth.

But at the same time it also creates the problems of i

Thus, the deficit financing has to be kept within mana

limits.


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Public Debt Policy

Taxation has a limited capacity to provide revenue to

government, especially for a poor country like India.

The government therefore takes recourse to public d

financing its developmental expenditure.

The public debt includes both internal as well as exte


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Internal Debt: This is the loan raised by the government from wcountry.

The Government takes loan from the public by issuing bonds ancertificates.

It may also take temporary loan from the RBI and also from combanks.

External Debt: This is the loan taken by the govt. from internat

financial institutions like IMF, WB . The loan may also be in the form of foreign capital know-how a

goods.

Apart from these the govt. may also take financial assistance frgovernments of developed countries.


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Merits of Fiscal Policy

1. Capital Formation: It helps in raising the capital for

a country and creates a favorable impact on the publprivate sector investment.

2. Mobilization of Resources: It helps mobilization of

through taxation.

3. Incentives to Savings: Through tax exemptions andconcessions, it provides incentives to raise savings.


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4. Inducement to Private Sector: Tax concessions and tax

exemptions give inducements to private sector to expandactivities.

5. Reduction of inequality: It helps to minimise the inequincome and wealth through progressive taxation.

6. Export Promotion: Through the various budgetary policoncessions and subsidies, the government has been try

promote exports. 7. Alleviation of Poverty and Unemployment: Through its

programs like IRDP, JRY, MNREGA it is trying to alleviate punemployment.


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Shortcomings of Fiscal Policy

1. Instability: The fiscal policy has failed to attain stab

many fronts. The growing deficit financing has createinflationary pressures.

2. Defective Tax Structure: The fiscal policy has failed

provide a suitable tax structure. Because of the failur

direct taxes, the country has to rely heavily on indirecincreasing the burden on the poor.


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3. Inflation: The higher rate of indirect taxation, the defic

financing and increasing volume of expenditure on nondevelopmental heads has raised the inflation levels.

The direct taxation has also failed to check the black mongiving rise to inflation.

4. Negative returns of the Public Sector: In spite of havin

investment in the public sector, the returns have largely negative, resulting in huge drain of public money.

5. Growing Inequality: The fiscal policy has failed to contgrowing inequality in the distribution of income and wea

Economic, Monetary and Fiscal Policies

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