Monetary Policy and Fiscal Policy.pptx
- 1. MONETARY POLICY AND FISCAL POLICY By Dr.Neerja sharma
- 2. MONETARY POLICY Monetary policy is the macroeconomic policy laid down by the central bank. It involves management of money supply and interest rate and is the demand side economic policy used by the government of a country to achieve macroeconomic objectives like inflation, consumption, growth and liquidity.
- 4. Rapid Economic Growth : It is the most important objective of a monetary policy. The monetary policy can influence economic growth by controlling real interest rate and its resultant impact on the investment. If the RBI opts for a cheap or easy credit policy by reducing interest rates, the investment level in the economy can be encouraged. This increased investment can speed up economic growth. Faster economic growth is possible if the monetary policy succeeds in maintaining income and price stability. Price Stability : All the economics suffer from inflation and deflation. It can also be called as Price Instability. Both inflation are harmful to the economy. Thus, the monetary policy having an objective of price stability tries to keep the value of money stable. It helps in reducing the income and wealth inequalities. When the economy suffers from recession the monetary policy should be an 'easy money policy' but when there is inflationary situation there should be a 'dear money policy'.
- 5. Exchange Rate Stability : Exchange rate is the price of a home currency expressed in terms of any foreign currency. If this exchange rate is very volatile leading to frequent ups and downs in the exchange rate, the international community might lose confidence in our economy. The monetary policy aims at maintaining the relative stability in the exchange rate. The RBI by altering the foreign exchange reserves tries to influence the demand for foreign exchange and tries to maintain the exchange rate stability. Balance of Payments (BOP) Equilibrium : Many developing countries like India suffers from the Disequilibrium in the BOP. The Reserve Bank of India through its monetary policy tries to maintain equilibrium in the balance of payments. The BOP has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. The former reflects an excess money supply in the domestic economy, while the later stands for stringency of money. If the monetary policy succeeds in maintaining monetary equilibrium, then the BOP equilibrium can be achieved.
- 6. Full Employment : The concept of full employment was much discussed after Keynes's publication of the "General Theory" in 1936. It refers to absence of involuntary unemployment. In simple words 'Full Employment' stands for a situation in which everybody who wants jobs get jobs. However it does not mean that there is a Zero unemployment. In that senses the full employment is never full. Monetary policy can be used for achieving full employment. If the monetary policy is expansionary then credit supply can be encouraged.
- 7. Neutrality of Money : Economist such as Wicksted, Robertson have always considered money as a passive factor. According to them, money should play only a role of medium of exchange and not more than that. Therefore, the monetary policy should regulate the supply of money. The change in money supply creates monetary disequilibrium. Thus monetary policy has to regulate the supply of money and neutralize the effect of money expansion. However this objective of a monetary policy is always criticized on the ground that if money supply is kept constant then it would be difficult to attain price stability. The neutrality of money theory is based on the idea that money is a “neutral” factor that has no real effect on economic equilibrium. Printing more money cannot change the fundamental nature of the economy, even if it drives up demand and leads to an increase in the prices of goods, services, and wages. Neutrality can be used broadly to describe individuals or organizations in relationship to any kind of dispute, but it most often refers to countries that don't engage in war. For example, Sweden has a long and famous tradition of neutrality, as it has not gone to war since 1814.
- 8. Neutrality of money is the idea that a change in the stock of money affects only nominal variables in the economy such as prices, wages, and exchange rates, with no effect on real variables, like employment, real GDP, and real consumption.
- 9. Equal Income Distribution : Many economists used to justify the role of the fiscal policy is maintaining economic equality. However in resent years economists have given the opinion that the monetary policy can help and play a supplementary role in attainting an economic equality. monetary policy can make special provisions for the neglect supply such as agriculture, small-scale industries, village industries, etc. and provide them with cheaper credit for longer term. This can prove fruitful for these sectors to come up. Thus in recent period, monetary policy can help in reducing economic inequalities among different sections of society. Control business cycle:- Boom and depression are main phases of business cycle, monetary policy puts a check on boom and depression. Promote export and substitute imports:- By providing concessional loans to export oriented and import substitution units, monetary policy encourages such industries and helps to improve the position of balance of payments.
- 10. Improvement in Standard of Living :- Monetary policy is also the major objective of the monetary policy that it should improve the quality of life in the country. Control of Inflation and Deflation:- Inflation and deflation both are not suitable for the economy. If the price level is reasonable and there is an adjustment between the price and cost, rate of out put can increase. Monetary policy is used to coordinate the cost and price. So price stability is achieved through the monetary policy. CONCLUSION:- Through all this points and references I concluded that the monetary policy is framed for the economic as well as for the control over the flow of money under different conditions that may cause by inflation or deflation in an economy there are many objectives of monetary policy as stated above which deals with how monetary policy affects the price and other factors,
- 11. What are the instruments of monetary policy? Some of the following instruments are used by RBI as a part of their monetary policies. Open Market Operations: An open market operation is an instrument which involves buying/selling of securities like government bond from or to the public and banks. The RBI sells government securities to control the flow of credit and buys government securities to increase credit flow. Cash Reserve Ratio (CRR): Cash Reserve Ratio is a specified amount of bank deposits which banks are required to keep with the RBI in the form of reserves or balances. The higher the CRR with the RBI, the lower will be the liquidity in the system and vice versa. The CRR was reduced from 15% in 1990 to 5 % in 2002. As of 31st December 2019, the CRR is at 4%. Statutory Liquidity Ratio (SLR): All financial institutions have to maintain a certain quantity of liquid assets with themselves at any point in time of their total time and demand liabilities. This is known as the Statutory Liquidity Ratio. The assets are kept in non-cash forms such as precious metals, bonds, etc. As of December 2019, SLR stands at 18.25%.
- 12. Bank Rate Policy: Also known as the discount rate, bank rates are interest charged by the RBI for providing funds and loans to the banking system. An increase in bank rate increases the cost of borrowing by commercial banks which results in the reduction in credit volume to the banks and hence the supply of money declines. An increase in the bank rate is the symbol of the tightening of the RBI monetary policy. As of 31 December 2019, the bank rate is 5.40%. Credit Ceiling: With this instrument, RBI issues prior information or direction that loans to the commercial bank will be given up to a certain limit. In this case, a commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. A few examples of credit ceiling are agriculture sector advances and priority sector lending.
- 13. FISCAL POLICY Fiscal policy is defined as the policy under which the government uses the instrument of taxation, public spending and public borrowing to achieve various objectives of economic policy. Simply put, it is the policy of government spending and taxation to achieve sustainable growth. The major purpose of these measures is to stabilize the economy. Fiscal policy measures are frequently used in tandem with monetary policy to achieve these macroeconomic goals.
- 14. Objectives of Fiscal Policy The following are the objectives of the Fiscal Policy: Higher Economic Growth Price Stability Reduction in Inequality The above objectives are met in the following ways: Consumption Control – This way, the ratio of savings to income is raised. Raising the rate of investment. Infrastructural development. Imposition of progressive taxes. Exemption from the taxes provided to the vulnerable classes. Heavy taxation on luxury goods. Discouraging unearned income.
- 15. What are the components of Fiscal Policy? There are three components of the Fiscal Policy of India: Government Receipts Government Expenditure Public Debt
- 16. Government Receipts The government's income in the form of Taxes, interests, and earnings on investments and other receipts for services rendered are altogether known as government receipts. This is the total amount of money received by the government from all sources. The government's revenue is what enables it to spend money. Government receipts are divided into two groups — Revenue Receipts & Capital Receipts. All Government receipts that either create liability or reduce assets are treated as capital receipts whereas receipts that neither create liability nor reduce assets of the Government are called revenue receipts. Sale of fixed assets, capital contribution and Profit on sale of assets, sale of goods. interest loans taken, etc., are some example of capital receipts. received on loans (advanced), royalty, etc., are some examples of revenue receipts.
- 17. Revenue Receipts Receipts that neither create liabilities nor reduce assets are called revenue receipts. Revenue Receipts can be subdivided into two: Tax and non-tax revenues. Tax revenues are of two types: direct and indirect taxes Nontax revenue sources are interest and dividend on government investment, cess and other receipts for services rendered by the government, income through licenses, permits, fines, penalties, etc.
- 18. Capital Receipts The government raises funds for its functioning in different ways which are known as capital receipts. These ways could either incur liabilities to the government or could be by disposing of its assets. Incoming cash flows is another term used for capital receipts. All kinds of borrowings, loans, etc. are treated as debt receipts as the government has to repay this money and, with its interests in some cases. There are non-debt receipts as well for the government which do not incur any future repayment burden for the government. Almost 75 percent of the total budget receipts are non-debt receipts. Loans from the general public, foreign governments, and the Reserve Bank of India (RBI) form a crucial part of capital receipts.
- 19. Government Expenditure The government’s expenditure can be classified into two: Revenue expenditures They are short-term expenses used in the current period or typically within one year. Revenue expenditures include the expenses required to meet the ongoing operational costs of the government, and thus are essentially the same as operating expenses (OPEX). Revenue expenditures also include the ordinary repair and maintenance costs that are necessary to keep an asset in working order without substantially improving or extending the useful life of the asset. Revenue expenditures can be considered to be recurring expenses in contrast to the one-off nature of most capital expenditures. Example: Salaries and employee wages, utilities, rents, property taxes on government-owned properties, etc.
- 20. Capital Expenditure Capital expenditures constitute investments made by the government in the capital, and more often, to maintain or to expand its business and generate additional revenue. Capital expenditures consist of the purchase of long-term assets, which are assets that last for more than one year but typically have a useful life of many years. Capital expenditures are often used for buying fixed assets, which are physical assets such as equipment. As a result, capital expenditures are typically for larger amounts than revenue expenditures. However, there are exceptions when large asset purchases are consumed in the short term or the current accounting period. Example: purchase of factory equipment, purchases for business, other government purchases like furniture, spending on infrastructure, etc.
- 21. Public Accounts of India (Public Debt) The Public Account of India accounts for flows for those transactions where the government is merely acting as a banker. This fund was constituted under Article 266 (2) of the Constitution. It accounts for flows for those transactions where the government is merely acting as a banker. Examples: provident funds, small savings, etc. These funds do not belong to the government, but rather have to be paid back at some time to their rightful owners. Therefore expenditures from the public account are not required to be approved by the Parliament.
- 22. Conclusion In this section, we learned about the components of fiscal policy. These components together function to affect the budget allocations, government spending, and key economic policy formulations for a financial year. The government expenditure and the government receipts must match while presenting a budget. Any shortfall in the receipts is raised through borrowing which results in a Fiscal Deficit.