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Monetetary and Fiscal policyRoshan Paudel

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Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates.

Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep in the vault (bank reserves).

Central bank is called monetary authority in the country and RBI is monetary Authority of India.

Monetary Policy

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According to Prof. Harry Johnson,"A policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy is a monetary policy."

According to A.G. Hart,"A policy which influences the public stock of money substitute of public demand for such assets of both that is policy which influences public liquidity position is known as a monetary policy.“

According to Reserve Bank of India “ Monetary policy refers to the use of instruments under the control of the central bank to regulate the availability, cost and use of money and credit.”

Definition

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Contractionary and expansionary1. Interest rates2. Reserve requirements3. Money supply, directly or indirectly

Types of monetary policy

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Secondary objective:Balance of Payments (BOP) EquilibriumFull EmploymentNeutrality of MoneyEqual Income Distribution

Objective Primary objective:Ensuring price stability, that is, containing inflation.To encourage economic growth.To ensure stability of exchange rate of the rupee,

that is, exchange rate of rupee with the US dollar, pound sterling and other foreign currencies.

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Bank Rate policy(BRP)OMOReserve Requirement(CRR and SLR)REPOREVERSE REPO

Instrument/ Tools of monetory policy

Quantitative Instruments or General Tools

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Fixing Margin RequirementsConsumer Credit RegulationPublicityCredit RationingMoral SuasionControl through DirectivesDirect Action

Qualitative Instruments or Selective Tools

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To Control Inflationary PressuresTo Achieve Price StabilityTo Bridge BOP DeficitTo Create habit of Banking and Financial InstitutionsDebt ManagementReforming Rural Credit SystemLong-Term Loans for Industrial DevelopmentMonetization of Economy

Role of monetary Policy in the Economy:Generally developing and underdeveloped economy

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Fiscal policy

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Fiscal policy  is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy

It is the decisions that a government makes regarding collection of revenue, through taxation and about spending that revenue.

“Fiscal policy deals with the taxation and expenditure decisions of the government. These include, tax policy, expenditure policy, investment or disinvestment strategies and debt or surplus management.”- Kaushik Basu 

Fiscal policy:

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Neutral fiscal policyit is usually undertaken when an economy is in equilibrium. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.

Expansionary fiscal policyit  involves government spending exceeding tax revenue, and is usually undertaken during recessions. It is also known as reflationary fiscal policy.

Contractionary fiscal policy it occurs when government spending is lower than tax revenue, and is usually undertaken to pay down government debt.

Types of fiscal policy

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Public expenditureTaxationPublic DebtTransfer payment

Instrument of fiscal policy

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Fiscal Policy for Full EmploymentFiscal Policy and Economic Stabilization

Fiscal Policy and Economic Growth

Fiscal Policy and Social Justice

Objective of fiscal policy

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Time lag а. Recognition Lag

b. Administrative Lag c. operational Lag

ForecastingCoordination with Monetary Policy(fiscal sensitivity)Political ConflictCrowding Out(self-offsetting Effect)Correct Size and Nature of Fiscal PolicyInadequacy of Fiscal MeasuresAdverse Effect on Redistribution of IncomeAdministrative Problems in Democratic Countries

Limitation of fiscal policy

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Can we exchange ideas?

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Can we exchange ideas?

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Can we exchange ideas?

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Types of inflation:On the basis of cause:

1. Demand pull inflation.2. Cost push inflation3.Credt inflation4.Deficit induce inflation5. Currency inflation

On the basis of government reaction:1. Open inflation2 Suppressed inflation

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Contd:On the basis of speed(time)1. creeping inflation2. Walking inflation3. Running inflation4. Galloping inflation5. Hyper inflation

Others6. Stagflation7. Core inflation8. Wage inflation9. Asset inflation

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Causes of inflationIncrease in demandIncrease in money supplyIncrease in public expenditureConsumer spending Population sizeSoft monetary policyDeficit financingExpansion of private sectorBlack moneyIncrease in exportRepayment of public debt

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Contd:

Factor affecting supplyShortage of FOPIndustrial disputeNatural calamities Lop-sided productionInternational factors

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High degree of inflation has adverse effects on the economy

First, inflation raises the cost of living of the people and hurts the poor most. Therefore, inflation has been described as enemy No. 1 of the poor. Inflation sends many people below the poverty line.

Secondly, inflation makes exports costlier and, therefore, discourages them. On the other hand, due to higher prices at home people are induced to import goods to a large extent. Thus, inflation has an adverse effect on the balance of payments.

Thirdly, when due to a higher rate of inflation value of money is rapidly falling, people do not have much incentive to save. This lowers the rate of saving on which investment and economic growth depend.

Fourthly, a high rate of inflation encourages businessmen to invest in the unproductive assets such as gold, jewellery, real estate etc.

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Control/ Measure of inflationMonetary measureCredit controlDemonetization of currencyIssue of new currencyFiscal measureReduction of unnecessary expenditureIncrease taxationEncourage to saveAppropriate budgetManagement of public debt.OthersIncrease productionRational wage policyPrice control or fixing priceManagement of resource

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Why little inflation is better?A little inflation (around 3-5%) is always considered as

good for overall growth of economy. The consumer always expects the prices of goods to

increase, so they spend more frequently, which increases demand and provide profitability to the manufacturers.

A little inflation is a sign of growing and healthy economy.

Inflation always works as a lubricant for any shock to economy and help it to recover. For example in a recession time cutting wages are considered more profitable than cutting jobs, but the earlier is not accepted easier than the later, and as we know job cuts are always bad for economy. But if there’s inflation in economy, employers just need to provide lesser raise than inflation rate and no one would mind.

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