Fiscal Policy 2 (1)

8/8/2019 Fiscal Policy 2 (1)

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MONETARY POLICY


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Monetary Policy

Monetary policy is the management of money supplyand interest rates by central banks to influence prices

and employment.Monetary policy works through expansion or

contraction of investment and consumption ofexpenditure.

At times of recession monetary policy involves theadoption of some monetary tools which tends toincrease the money supply and lower interest rate.

At the time of inflation monetary policy seeks tocontract aggregate spending by tightening the money

supply or raising the rate of return.

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The uses of Monetary PolicyThere is no long-term tradeoff between growth

and inflation. (High inflation can only hurtgrowth).

What monetary policy at its best can deliver islow and stable inflation, and thereby reduce thevolatility of the business cycle.

When inflationary pressures build up: raise theshort-term interest rate (the policy rate) whichraises real rates across the economy whichsqueezes consumption and investment.

It is not concentrated at a few points, as is the casewith government interventions in commodity

markets. 3


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Three Important Objectives To ensure the economic stability at full

employment or potential level of output.

To achieve price stability by controllinginflation and deflation.

To promote and encourage economic growth

in the economy. 4


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Tools Of Monetary Policy

Bank rate policy

Open market operations Changing Cash Reserve Ratio

Statutory Liquidity Ratio

Changes in repo rate and reverse repo rate Net purchase of foreign currency assets

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Bank Rate policy Bank rate is the minimum rate at which the

central bank of a country provides loan to the

commercial bank of the country.

Bank rate is also called discount rate becausebank provide finance to the commercial bankby rediscounting the bills of exchange.

When central bank raises the bank rate, thecommercial bank raises their lending rates, itresults in less borrowings and reduces moneysupply in the economy. 6


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Open Market Operations

It means the purchase and sale of

securities by central bank of the country.

It is useful for the developed countries.

The sale of security by the central bankleads to contraction of credit and purchasethere of to credit expansion.

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Cash reserve Ratio The bank have to keep certain amount of

bank money with themselves as reserves

against deposits. The increase in the cash rate leads to the

contraction of credit only when the banks

excess reserves. The decrease in the cash rate leads to the

expansion of credit and banks tends to

make more available borrowers.8


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STATUTORY LIQUIDITY RATIO

Statutory Liquidity Ratio (SLR) is a term used

in the regulation of banking in India.

It is the amount which a bank has to maintainin the form of cash, gold or approved

securities.

The objectives of SLR are :-

1)To restrict the expansion of bank credit.

2)To augment the investment of the banks in

Government securities.

3)To ensure solvency of banks.


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Repo rate System It is introduced through which RBI can add to

liquidity in the banking system. Through repo

system RBI buys securities from the bank andthere by provide funds to them.

Repo refers to agreement for a transaction

between RBI and banks through which RBIsupplies funds immediately against governmentsecurities and simultaneously agree to repurchasethe same or similar securities after a specifiedtime which may be one day to 14 days.

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IntroductionFiscal policy refers to the government policies

regarding taxation, public borrowing and public

expenditure with specific objectives in view. Its main objective is to achieve economic

development.

The use of fiscal policy as an economic tool was

proposed by Keynes and gained popularity during

the time of Great Depression.


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Economic StabilizationFiscal policy responses to economic instability into ways:

Automatic Stabilizers: built-in stabilizers Incremental Tax Rates Tax rate applicableincreases as the income increases.

Unemployment compensation and Welfarepayments.

Discretionary Fiscal Policy: deliberate changesundertaken by the government in the tax rates andplanned outlays.


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Fiscal Policy And

Macroeconomic Goals Economic Growth: By creating conditions for

increase in savings & investment.

Revenue mobilization: mobilization of resourcesthrough taxation.

Allocational efficiency: efficient and rational

allocation of resources.

Stabilization: fight with depressionary trends andbooming (overheating) indications in the economy

Economic Equality: By reducing the income and

wealth gaps between the rich and poor.


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Instruments of Fiscal Policy Taxation- direct and indirect

Public borrowing

Deficit financing

Public expenditure


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Taxation It is the most important source of public

revenue.

It determines the level of disposable incomewith the individuals

Classified into

1.Direct taxes- Corporate tax, Div. Distribution Tax,Personal Income Tax, Fringe Benefit taxes, BankingCash Transaction Tax

2. Indirect taxes- Central Sales Tax, Customs, Service

Tax, excise duty.


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Public Borrowing Internal borrowings1. Borrowings from the public by means of treasury bills

and govt. bonds

2. Borrowings from the central bank (monetized deficitfinancing)

External borrowings

1. foreign investments

2. international organizations like World Bank &IMF

3. market borrowings


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Deficit Financing When government spendings are more than

revenue.

Keeping budget balanced (R=E) or deficit(RE) as a matter of

policy is itself a fiscal instrument.

It is used as a tool to boost employment. The gap between expenditure and revenue

is filled by deficit financing


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Government Expenditure It includes :

Government spending on the purchase of goods &

services. Expenditure on providing basic facilities to thepublic

Undertaking infrastructural projects

Payment of wages and salaries of governmentservants

Public investment

Transfer payments


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Some problems Lags in fiscal policy

Problems in tax policy

Burden of public debt

The dangers of deficit financing

Fiscal Policy 2 (1)

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