fiscal & monetary policy-3

7/30/2019 Fiscal & Monetary Policy-3

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Module-5


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Fiscal policy is based on the theories ofBritish economist John Maynard Keynes.

Also known as Keynesian economics, thistheory basically states that governments can

influencemacroeconomic productivity levels by

increasing or decreasing tax levels and publicspending.

This influence, in turn, curbs inflation,increases employment and maintains ahealthy value of money.


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Fiscal policy basically means by which agovernment adjusts its levels of spending inorder to monitor and influence a nation'seconomy.

It refers to the union government's use of itsannual budget to affect the level of economic

activity, resource allocation and incomedistribution.

The budget strategy can also influence the

achievement of the government's objectives ofinternal and external balance and economicgrowth


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The two main instruments of fiscal policy aregovernment spending and taxation

1. The pattern of resource allocation; and

2. The distribution of income.


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1. A neutral stance of fiscal policy implies abalanced budget where G = T (Governmentspending = Tax revenue). Governmentspending is fully funded by tax revenue.

2. An expansionary stance of fiscal policyinvolves a net increase in government

spending (G > T) through a rise in

government spending or a fall in taxationrevenue or a combination of the two.


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3. Contractionary fiscal policy (G < T) occurswhen net government spending is reducedeither through higher taxation revenue orreduced government spending or a

combination of the two. This would lead to alower budget deficit.


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Interest payments Subsidies Capital Outlays Wages, Salaries and Pensions Defence


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Taxation:I. Income Tax VII.Excise DutyII. Witholding tax VIII.Customs DutyIII. Sales tax Etc.IV. Stamp dutyV. Capital gain taxVI. VAT


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Seignorage Funding of Deficits A fiscal deficit is often funded by issuing

bonds, like Treasury bills or Controls. These pay interest, either for a fixed period

or indefinitely.

If the interest and capital repayments are too

great, a nation may default on its debts,usually to foreign debtors.


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To Grow with all Sectors of Economy. To Grow with the People of the Country. To become self sufficient & To Serve the World. Indian Fiscal Policy has been able to satisfy all

the above factors up to the mark or almost

there. This can be clearly seen from the belowStatistics & Growth Graphs.


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-7.211 (Re)


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5280


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Rs.345878(Cr.)


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26524 (USMillion $)


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11008 (US Million $)


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12TH Largest Economy in the World as perGDP in US DOLLARS

3RD Largest Economy in the World as perGDP in US DOLLAR (PURCHASING POWER

PARITY) 2nd Fast largest paramilitary force in the

world. Indian Army is the third-largest army in the

world. Indian Air Force is the fourth-largest air force

in the world.


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India is ranked the 6th Country in the Worldin Terms of Satellite Launches.

Navy is the fifth largest in the world.

Of the Fortune 500 companies, 220outsource their Software-related work toIndia.

There are over 70,000 Bank Branches in India

- among the highest in the World.


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BENCH SETTER: Indian Railways is the Largest Railway

Network in the World under Singlemanagement employing just over 1.6 millionemployees Making it LARGEST EMPLOYER.


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Fiscal deficit=Revenue receipts+recoveries ofloans+other receipts- total expenditure.

Revenue deficit =RR-RE

Budgetary deficit =TR-TE

Primary deficit= Fiscal deficit-interestpayments


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Monetary policy is the management of moneysupply and interest rates by central banks toinfluence prices and employment.

It refers to those measures adopted by acentral banking authorities, using creditpolicy and monetary policy to manage creditcontrol.

Monetary policy works through expansion orcontraction of investment and consumptionexpenditure.


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Price stability Stability of foreign exchange rate

Full employment

High rate of economic growth Equitable distribution of income


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Monetary policy cannot change long-termtrend growth.

There is no long-term tradeoff betweengrowth and inflation. (High inflation can onlyhurt growth).

What monetary policy at its best candeliver is low and stable inflation, and

thereby reduce the volatility of the businesscycle.


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When inflationary pressures build up:raise theshort-term interest rate (the policy rate)

which raises real rates across the economy

which squeezes consumption andinvestment.

The pain is not concentrated at a few points,as is the case with government interventions

in commodity markets.


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General/quantitative method Selective/qualitative method of credit control


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Bank rate policy Open market operations

CRR


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Dear money policy Cheap money policy


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It deals with buying and selling of securitiesby the central bank.

It has direct influence on money circulationand cash reserve of the commercial banks.

Central bank purchases securities when itwants to expand credit.


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The central bank enjoys power to determinethe statutory CRR of the commercial banks.

The commercial banks has to maintaincertain % of their demand and time deposits

with the central bank as deposits.


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Rationing of credit

Direct action

Variable margin requirement Regulation of consumer credit

Moral suasion

Deficit financing


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The central bank may issue directions tocommercial banks to restrict credit to certainsectors of the population.

This method is particularly useful in

controlling inflationary pressures.


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It means the forceful measures adoptedagainst those commercial banks which havecommitted errors.


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VM is used to reduce speculation andhoarding activities by traders.

The central bank rises the marginrequirement.

Ex.storing of food grains

50%-20lakhs,75%-20 lakhs


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Regulation of consumer credit is resorted toonly under severe inflationary conditions isan effort to restrict consumer demand forcredit.

Ex. Credit given for purchase of consumerdurable goods may be charged very high rateof interest to discourage borrowing for thispurpose by the consumer. This results in afall of demand and there by fall in the price ofgoods.


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MS is used by the central Govt. to putpressure on the lending activities of thecommercial banks by using them tovoluntarily adopt certain restrictive practices.


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It is a method adopted to cover the budgetarygap by resorting to loans from the banks indeveloped countries.

However in developing countries resort is madeto the central bank which merely prints more

notes to cover the deficits. Deficit financing results in an increase in the level

of expenditure of commodity because it involvesthe increase in total money supply.since there isa creation of new money, it results in inflation

and as a result the PP in the hands of the peopleincreases, but the production of goods does notincrease simultaneously.


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Fixed by RBI M1 Narrow Money = Currency + Coins +

Current Accounts

M3 Broad Money = M1+Savings Deposits+ Fixed Deposits + Post Office


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CRR Cash Reserve Ratio Now at 5%

In 1991 it was 15%

SLR 25% Gold Cash & Eq

Approved RBI Bonds eg Agricultural

In 1991 it was 38.5%


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Bank Rate 6% Repo rate 6.5%

Reverse Repo 5.5%

What is Repo?? Banks buying Securities from RBI - reverse repo

Short Term loans typically 15 days


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PLR Prime Lending Rate 10.25 10.75% Savings Deposit 3.5%

Call Money 4% - 5.65%

FD 5.25 6.25 %, 10 years ago as much as14 - 15%

Inflation 3-6% in the last 3 years


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Changing Reserve Ratios Bank Rate

Open Market Operations


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Mostly in tandem with Fiscal Policy Stock Markets

Assets Valuation like Real Estate, Gold,Commodities

Least Inflation Policy since 1999-00

Jobs/Ouput Short Term Effects

Jalan Monetary Policy a non event


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Net loans to central government (i.e. openmarket operations)

Net purchase of foreign currency assets

Change in cash reserve ratio

Changes in repo rate and reverse repo rate

Bank rate

fiscal & monetary policy-3

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