Monetary policy

MONETARY ANDMONETARY AND
FISCAL POLICIESFISCAL POLICIES

InflationInflation
InflationInflation is a rise in the generalis a rise in the general
level of prices of goods andlevel of prices of goods and
services in an economy over aservices in an economy over a
period of time. When the priceperiod of time. When the price
level rises, each unit of currencylevel rises, each unit of currency
buys fewer goods and services.buys fewer goods and services.
A chief measure of price inflationA chief measure of price inflation
is the inflation rate.When Pricesis the inflation rate.When Prices
rise the Value of Money falls.rise the Value of Money falls.

STAGES OF INFLATIONSTAGES OF INFLATION
 1. CREEPING INFLATION (0%-3%)1. CREEPING INFLATION (0%-3%)
 2. WALKING INFLATION ( 3% -2. WALKING INFLATION ( 3% -
7%)7%)
 3. RUNNING INFLATION3. RUNNING INFLATION (10% - 20(10% - 20
%)%)


TYPES OF INFLATIONTYPES OF INFLATION
1. Demand Pull Inflation1. Demand Pull Inflation
2. Cost Push Inflation2. Cost Push Inflation

Causes of InflationCauses of Inflation
 1. Demand pull Inflation1. Demand pull Inflation
Causes for Increase in Demand :-Causes for Increase in Demand :-
a)a)Increase in Money SupplyIncrease in Money Supply
b)b)Increase in Black MarketingIncrease in Black Marketing
c)c) Increase in HoardingIncrease in Hoarding
d)d)Repayment of Past Internal DebtRepayment of Past Internal Debt
e)e)Increase in ExportsIncrease in Exports
f)f) Deficit FinancingDeficit Financing

Cont……….Cont……….
g) Increase in Incomeg) Increase in Income
h) Demonstration Effecth) Demonstration Effect
i) Increase in Black moneyi) Increase in Black money
j) Increase in Credit facilitiesj) Increase in Credit facilities

Cont….Cont….
 2) Cost Push Inflation2) Cost Push Inflation
Causes for Increase in Cost :-Causes for Increase in Cost :-
a)a)Increase in cost of raw materialsIncrease in cost of raw materials
b)b)Shortage of SuppliesShortage of Supplies
c)c)Natural calamitiesNatural calamities
d)d)Industrial DisputesIndustrial Disputes
e)e)Increase in ExportsIncrease in Exports
f)f) Increase in WagesIncrease in Wages
g)g)Increase in Transportation CostIncrease in Transportation Cost
h)h)Huge Expenditure on AdvertisementHuge Expenditure on Advertisement

Effects of InflationEffects of Inflation
 Inflation can have positive and negativeInflation can have positive and negative
effects on an economy. Negative effects ofeffects on an economy. Negative effects of
inflation include loss in stability in the realinflation include loss in stability in the real
value of money and other monetary itemsvalue of money and other monetary items
over time; uncertainty about future inflationover time; uncertainty about future inflation
may discourage investment and saving, andmay discourage investment and saving, and
high inflation may lead to shortages ofhigh inflation may lead to shortages of
goods if consumers begin hoarding out ofgoods if consumers begin hoarding out of
concern that prices will increase in theconcern that prices will increase in the
future. Positive effects include a mitigationfuture. Positive effects include a mitigation
of economic recessions, and debt relief byof economic recessions, and debt relief by
reducing the real level of debt.reducing the real level of debt.

Cont…..Cont…..
1.1. Effect on ProducersEffect on Producers
2.2. Effect on DebtorsEffect on Debtors
3.3. Effect on CreditorsEffect on Creditors
4.4. Effect on Fixed Income GroupEffect on Fixed Income Group
5.5. Effect on Wage EarnersEffect on Wage Earners
6.6. Effect on Equity HoldersEffect on Equity Holders
7.7. Effect on farmersEffect on farmers
8.8. Effect on ProdutionEffect on Prodution

9.Effect on Hoarding9.Effect on Hoarding
10.Effect on value of Money10.Effect on value of Money
11.Effect on Investment11.Effect on Investment
12. Effect on savings12. Effect on savings

What is the MonetaryWhat is the Monetary
Policy?Policy? The Monetary and Credit Policy is the policyThe Monetary and Credit Policy is the policy
statement, traditionally announced twice astatement, traditionally announced twice a
year, through which the Reserve Bank ofyear, through which the Reserve Bank of
India seeks to ensure price stability for theIndia seeks to ensure price stability for the
economy.economy.
These factors include - money supply,These factors include - money supply,
interest rates and the inflation. In banking andinterest rates and the inflation. In banking and
economic terms money supply is referred toeconomic terms money supply is referred to
as M3 - which indicates the level (stock) ofas M3 - which indicates the level (stock) of
legal currency in the economy.legal currency in the economy.
Besides, the RBI also announces norms forBesides, the RBI also announces norms for
the banking and financial sector and thethe banking and financial sector and the
institutions which are governed by it.institutions which are governed by it.

How is the Monetary PolicyHow is the Monetary Policy
different from the Fiscaldifferent from the Fiscal
Policy?Policy?
 The Monetary Policy regulates the supply of money and theThe Monetary Policy regulates the supply of money and the
cost and availability of credit in the economy. It deals withcost and availability of credit in the economy. It deals with
both the lending and borrowing rates of interest forboth the lending and borrowing rates of interest for
commercial banks.commercial banks.
 The Monetary Policy aims to maintain price stability, fullThe Monetary Policy aims to maintain price stability, full
employment and economic growth.employment and economic growth.
 The Monetary Policy is different from Fiscal Policy as theThe Monetary Policy is different from Fiscal Policy as the
former brings about a change in the economy by changingformer brings about a change in the economy by changing
money supply and interest rate, whereas fiscal policy is amoney supply and interest rate, whereas fiscal policy is a
broader tool with the government.broader tool with the government.
 The Fiscal Policy can be used to overcome recession andThe Fiscal Policy can be used to overcome recession and
control inflation. It may be defined as a deliberate change incontrol inflation. It may be defined as a deliberate change in
government revenue and expenditure to influence the levelgovernment revenue and expenditure to influence the level
of national output and prices.of national output and prices.

What are the objectives ofWhat are the objectives of
the Monetary Policy?the Monetary Policy?
 The objectives are to maintain price stabilityThe objectives are to maintain price stability
and ensure adequate flow of credit to theand ensure adequate flow of credit to the
productive sectors of the economy.productive sectors of the economy.
Stability for the national currency (afterStability for the national currency (after
looking at prevailing economic conditions),looking at prevailing economic conditions),
growth in employment and income are alsogrowth in employment and income are also
looked into. The monetary policy affects thelooked into. The monetary policy affects the
real sector through long and variablereal sector through long and variable
periods while the financial markets are alsoperiods while the financial markets are also
impacted through short-term implications.impacted through short-term implications.

INSTRUMENTS OFINSTRUMENTS OF
MONETARY POLICYMONETARY POLICY
 1. Bank Rate of Interest1. Bank Rate of Interest
 2. Cash Reserve Ratio2. Cash Reserve Ratio
 3. Statutory Liquidity Ratio3. Statutory Liquidity Ratio
 4. Open market Operations4. Open market Operations
 5. Margin Requirements5. Margin Requirements
 6. Deficit Financing6. Deficit Financing
 7. Issue of New Currency7. Issue of New Currency
 8. Credit Control8. Credit Control

Bank Rate of InterestBank Rate of Interest
It is the interest rate which is fixed by the RBI to control theIt is the interest rate which is fixed by the RBI to control the
lending capacity of Commercial banks . During Inflation ,lending capacity of Commercial banks . During Inflation ,
RBI increases the bank rate of interest due to whichRBI increases the bank rate of interest due to which
borrowing power of commercial banks reduces whichborrowing power of commercial banks reduces which
thereby reduces the supply of money or credit in thethereby reduces the supply of money or credit in the
economy .When Money supply Reduces it reduces theeconomy .When Money supply Reduces it reduces the
purchasing power and thereby curtailing Consumption andpurchasing power and thereby curtailing Consumption and
lowering Prices.lowering Prices.

Cash Reserve RatioCash Reserve Ratio
CRR, or cash reserve ratio, refers to a portion ofCRR, or cash reserve ratio, refers to a portion of
deposits (as cash) which banks have to keep/maintaindeposits (as cash) which banks have to keep/maintain
with the RBI. During Inflation RBI increases the CRRwith the RBI. During Inflation RBI increases the CRR
due to which commercial banks have to keep a greaterdue to which commercial banks have to keep a greater
portion of their deposits with the RBI . This serves twoportion of their deposits with the RBI . This serves two
purposes. It ensures that a portion of bank deposits ispurposes. It ensures that a portion of bank deposits is
totally risk-free and secondly it enables that RBI controltotally risk-free and secondly it enables that RBI control
liquidity in the system, and thereby, inflation.liquidity in the system, and thereby, inflation.

Statutory LiquidityStatutory Liquidity
RatioRatio
Banks are required to invest a portion ofBanks are required to invest a portion of
their deposits in government securitiestheir deposits in government securities
as a part of their statutory liquidity ratioas a part of their statutory liquidity ratio
(SLR) requirements . If SLR increases(SLR) requirements . If SLR increases
the lending capacity of commercial banksthe lending capacity of commercial banks
decreases thereby regulating the supplydecreases thereby regulating the supply
of money in the economy.of money in the economy.

Open marketOpen market
OperationsOperations
It refers to the buying and selling ofIt refers to the buying and selling of
Govt. securities in the open market .Govt. securities in the open market .
During inflation RBI sells securities in theDuring inflation RBI sells securities in the
open market which leads to transfer ofopen market which leads to transfer of
money to RBI.Thus money supply ismoney to RBI.Thus money supply is
controlled in the economy.controlled in the economy.

Margin RequirementsMargin Requirements
 During Inflation RBI fixes a high rate ofDuring Inflation RBI fixes a high rate of
margin on the securities kept by themargin on the securities kept by the
public for loans .If the margin increasespublic for loans .If the margin increases
the commercial banks will give lessthe commercial banks will give less
amount of credit on the securities kept byamount of credit on the securities kept by
the public thereby controlling inflation.the public thereby controlling inflation.

Deficit FinancingDeficit Financing
 It means printing of new currency notesIt means printing of new currency notes
by Reserve Bank of India .If more newby Reserve Bank of India .If more new
notes are printed it will increase thenotes are printed it will increase the
supply of money thereby increasingsupply of money thereby increasing
demand and prices.demand and prices.
 Thus during Inflation, RBI will stopThus during Inflation, RBI will stop
printing new currency notes therebyprinting new currency notes thereby
controlling inflation.controlling inflation.

Issue of New CurrencyIssue of New Currency
 During Inflation the RBI will issue newDuring Inflation the RBI will issue new
currency notes replacing many oldcurrency notes replacing many old
notes.notes.
This will reduce the supply of money inThis will reduce the supply of money in
the economy.the economy.

Fiscal PolicyFiscal Policy
 It refers to the Revenue and ExpenditureIt refers to the Revenue and Expenditure
policy of the Govt. which is generallypolicy of the Govt. which is generally
used to cure recession and maintainused to cure recession and maintain
economic stability in the country.economic stability in the country.

Instruments of FiscalInstruments of Fiscal
PolicyPolicy
 1. Reduction of Govt. Expenditure1. Reduction of Govt. Expenditure
 2. Increase in Taxation2. Increase in Taxation
 3. Imposition of new Taxes3. Imposition of new Taxes
 4. Wage Control4. Wage Control
 5.Rationing5.Rationing
 6. Public Debt6. Public Debt
 7. Increase in savings7. Increase in savings
 8. Maintaining Surplus Budget8. Maintaining Surplus Budget

Other MeasuresOther Measures
 1. Increase in Imports of Raw materials1. Increase in Imports of Raw materials
 2. Decrease in Exports2. Decrease in Exports
 3. Increase in Productivity3. Increase in Productivity
 4. Provision of Subsidies4. Provision of Subsidies
 5. Use of Latest Technology5. Use of Latest Technology
 6. Rational Industrial Policy6. Rational Industrial Policy

Monetary policy

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Monetary policy