Fiscal policy and monetary policy

Fiscal Policy and Monetary Policy

1. Submitted To:
Dr. Preeti Sharma Ma’am
Submitted By:
MBA (A) Group 1
Utkarsh Sharma
Sorabh Sharma
Vivek Rudhra
Mohit Panwar

2. MACROECONOMIC POLICIES

3. MONETARY POLICIES
MACROECONOMIC
POLICIES
MONETARY POLICY
Regulated by Central
Bank and Commercial
Banks

4. MONETARY POLICY
MEANING :
Monetary policy refers to the steps taken by the RBI to regulate the cost & supply of money & credit in
order to achieve the socio-economic objectives of the economy. Monetary policy influences the supply
of money the cost of money or the rate of interest and the availability of money.
DEFINITION OF MONETARY POLICY
According to D.C. ROWAN , `` Discretionary act undertaken by the authorities designed to influence
(a)The supply of money
(b)Cost of money or rate of interest and
(c)The availability of money.”
•Basis of Monetary Policy is that there is a long run relationship between the amount of money and
inflation.
•Demand for Money – the amount people wish to hold as cash as opposed to other assets.
•The Supply of Money – the amount of money in circulation in the economy

5. OBJECTIVES OF MONETARY POLICY
•Full Employment
•Price Stability
•Economic Growth
•Balance of Payments
•Controlled expansion
•To Regulate and Expand Banking

6. OBJECTIVES OF MONETARY POLICY
Full Employment :
Full employment has been ranked among the foremost objectives of monetary policy. It is an important
goal not only because unemployment leads to wastage of potential output, but also because of the loss of
social standing and self-respect.
Price Stability :
One of the policy objectives of monetary policy is to stabilise the price level. Both economists and laymen
favour this policy because fluctuations in prices bring uncertainty and instability to the economy.
Economic Growth :
One of the most important objectives of monetary policy in recent years has been the rapid economic
growth of an economy. Economic growth is defined as “the process whereby the real per capita income of a
country increases over a long period of time.”
Balance of Payments :
Another objective of monetary policy since the 1950s has been to maintain equilibrium in the balance of
payments.
Controlled Expansion :
Control business cycle, Promote export and substitute imports, Promotes savings and expansion, By
ensuring more credit for priority sector.
To Regulate and Expand Banking :
Give directives to different banks for setting up branches for promoting agriculture credit.

7. TOOLS OF MONETARY POLICY

8. TOOLS OF MONETARY POLICY
They affect the level of aggregate demand through the supply of money, cost of money and
availability of credit. Of the two types of instruments, the first category includes bank rate
variations, open market operations and changing reserve requirements. They are meant to
regulate the overall level of credit in the economy through commercial banks. The selective
credit controls aim at controlling specific types of credit. They include changing margin
requirements and regulation of consumer credit.
We discuss them as under:

9. Quantitative Measures
General or Indirect
TOOLS OF MONETARY POLICY
Interest Rate
Bank Rate : RBI provides refinance to banks against funds deployed
by banks in specified sectors such as export finance portfolio of the
banks
Changes in the bank rate are a signal to the market regarding the
direction in which the RBI would like interest rates to move.
Repo Rate : Repo rate or repurchase rate is a swap deal involving
the immediate sale of securities and simultaneous purchase of those
securities at a future date, at a designated price. It could also be an
overnight deal with sale taking place on day one and repurchase on
day two . RBI uses repo and reverse repo to control liquidity on a day-
to-day basis. India’s current repo rate is fixed at 6% w.e.f. 2
nd
August.
Reverse Rate : When Reserve Bank of India faces a financial
crunch, they invite commercial banks and other financial institutions
to deposit their excess funds into RBI treasury and offers them
excellent interest rates.
India’s current reverse repo rate is fixed at 5.75%
MSF (Marginal Standing Facility)
Marginal Standing Facility (MSF) rate refers to the rate at which the
scheduled banks can borrow funds overnight from RBI at the time of
acute shortage of funds. To stem the continuing fall of rupee, the RBI
raised the MSF rate 3%) in July 2013.
India’s current MSF is fixed at 6.25%

10. TOOLS OF MONETARY POLICY
Quantitative Measures
General or Indirect
Cash Reserve Ratio (CRR)
It refers to the minimum percentage of a bank’s total
deposits by the customers required to be kept with the
Central Bank in the form of cash reserves.
Presently in India, banks are required to maintain the
following reserves:
Cash Reserve ratio: 4% of demand and time deposits
HIGH CRR – less credit availability –will reduce the money
supply
Low CRR – more credit availability will increase the
money supply
Just as additional cash inflows enable the banking system
to create credit, any increase in CRR will require the
banking system to contract credit by a large amount
Statutory Liquidity ratio (SLR)
Every bank is required to maintain a fixed percentage of its
assets in the form of cash or other liquid assets, called SLR.
SLR (Statutory Liquidity ratio) is a requirement peculiar to
India. In addition to ensuring that banks can fall back on the
readily saleable government deposits in the event of a run
on the bank, it was a prescription to divert bank deposits to
meet government investment expenditure.
Presently in India, banks are required to maintain the
following reserves:
Statutory Liquidity ratio: 20% of demand and time deposits
HIGH SLR – less credit availability –will reduce the money
supply
Low SLR– more credit availability will increase the money
supply

11. TOOLS OF MONETARY POLICY
Quantitative Measures
General or Indirect
Open Market Operations
Banks as well as other financial institutions, such as insurance companies, mutual funds and corporate with surplus cash are big
investors in government securities. When RBI wishes to inject liquidity into the market, it has another option of buying government
securities. When RBI offers to buy the securities at a rate that is better than the rate prevailing in the market, some of the investors
can sell their holdings and the cash inflow would lead to credit creation of a large magnitude.
Similarly, when RBI sells government securities at a higher rate than market rate, RBI absorbs funds and the banking system
contracts credit by a large magnitude to reduce liquidity. This is known as open market operation.

12. TOOLS OF MONETARY POLICY
Qualitative Measures
Selective or Direct DIRECT ACTION :
The central bank may initiate direct action against member banks in case these
do no comply with its directives.
Direct action includes de-recognition of a commercial bank as a member of the
country’s banking system.
MORAL SUASION :
It is a combination of both ‘persuasion’ and ‘pressure’.
The Central bank tries to persuade the commercial banks to follow its directives
of monetary policy. Otherwise, it can pressurize them to follow its policy
directives.
RATIONING OF Credit :
It refers to fixation of credit quotas for different business activities.
The commercial banks cannot exceed the quota limits while granting loans.

13. TOOLS OF MONETARY POLICY
Margin Requirement : The margin requirement of loan refers to the
difference between the current value of the security offered for loans and the
value of loans granted .
Selective Credit Controls : Selective credit controls are used to
influence specific types of credit for particular purposes. They usually take
the form of changing margin requirements to control speculative activities
within the economy. When there is brisk speculative activity in the economy
or in particular sectors in certain commodities and prices start rising, the
central bank raises the margin requirement on them.
The result is that the borrowers are given less money in loans against
specified securities. For instance, raising the margin requirement to 60%
means that the pledger of securities of the value of Rs 10,000 will be given
40% of their value, i.e. Rs 4,000 as loan. In case of recession in a particular
sector, the central bank encourages borrowing by lowering margin
requirements.
Qualitative Measures
Selective or Direct

14. The Interest Rate Transmission Mechanism
Interest
Rates
Borrowing
Individuals
Credit
Loans
Consumption
Firms
New
Loans
Investment
Existing Loans
Costs EmploymentMargins Consumption

15. FISCAL POLICIES
MACROECONOMIC
POLICIES
MONETARY POLICY
Government Income Government Expenditure

16. FISCAL POLICY
MEANING
•The fiscal policy is concerned with the raising of government revenue and incurring of government
expenditure. To generate revenue and to incur expenditure.
• To generate revenue and to incur expenditure, the government frames a policy called budgetary policy or
fiscal policy. So, the fiscal policy is concerned with government expenditure and government revenue.
•Fiscal policy has to decide on the size and pattern of flow of expenditure from the government to the
economy and from the economy back to the government.
•In broad term fiscal policy refers to "that segment of national economic policy which is primarily
concerned with the receipts and expenditure of central government.
Who control fiscal policy
In India the president central and the state government together control the fiscal policy.
INFLUENCES
•Influence Aggregate Demand –
•Tax regime influences consumption (C) and investment (I)
•Government Spending (G)
•Influences key economic objectives.
•Also used to influence non-economic objectives and provide framework for supply side policy.
•e.g. education and health, poverty reduction, welfare reform, investment, regional policies,
promotion of enterprise, etc.

17. TYPES OF FISCAL POLICY

18. TYPES OF FISCAL POLICY

19. OBJECTIVES OF FISCAL POLICY
Development by effective Mobilization of Resources
The financial resources can be mobilized by:
•Public Savings : The resources can be mobilized through public savings by reducing
government expenditure and increasing surpluses of public sector enterprises.
•Private Savings : Through effective fiscal measures such as tax benefits, the government
can raise resources from private sector and households.
•Taxation : Through effective fiscal policies, the government aims to mobilize resources by
way of direct taxes as well as indirect taxes because most important source of resource
mobilization in India is taxation.
Efficient allocation of Financial Resources
•The central and state governments have tried to make efficient allocation of financial
resources. These resources are allocated for Development Activities which includes
expenditure on railways, infrastructure, etc.
•While Non-development Activities includes expenditure on defense, interest payments,
subsidies, etc.
•But generally the fiscal policy should ensure that the resources are allocated for generation of
goods and services which are socially desirable.
•Therefore, India's fiscal policy is designed in such a manner so as to encourage production of
desirable goods and discourage those goods which are socially undesirable.

20. OBJECTIVES OF FISCAL POLICY
Reduction in inequalities of Income and Wealth
•Fiscal policy aims at achieving equity or social justice by reducing income inequalities
among different sections of the society. The direct taxes such as income tax are charged more
on the rich people as compared to lower income groups.
•Indirect taxes are also more in the case of semi-luxury and luxury items, which are mostly
consumed by the upper middle class and the upper class.
Price Stability and Control of Inflation
•One of the main objective of fiscal policy is to control inflation and stabilize price. Therefore,
the government always aims to control the inflation by Reducing fiscal deficits, introducing
tax savings schemes, Productive use of financial resources, etc.
Reduction in inequalities of Income and Wealth
•Fiscal policy aims at achieving equity or social justice by reducing income inequalities
among different sections of the society. The direct taxes such as income tax are charged more
on the rich people as compared to lower income groups.
•Indirect taxes are also more in the case of semi-luxury and luxury items, which are mostly
consumed by the upper middle class and the upper class.

21. OBJECTIVES OF FISCAL POLICY
Increase capital
•The objective of fiscal policy in India is also to increase the rate of capital formation so as to
accelerate the rate of economic growth.
•In order to increase the rate of capital formation, the fiscal policy must be efficiently designed
to encourage savings and discourage and reduce spending.
Increase National Income
•The fiscal policy aims to increase the national income of a country. This is because fiscal
policy facilitates the capital formation. This results in economic growth, which in turn
increases the GDP, per capita income and national income of the country.
Foreign Exchange Earnings
•Fiscal policy attempts to encourage more exports by way of Fiscal Measures like, exemption
of income tax on export earnings, exemption of sales tax and octroi, etc.
•Foreign exchange provides fiscal benefits to import substitute industries.

22. EFFECTS OF FISCAL POLICY

23. MEASURES OF FISCAL POLICY

24. Key Differences between FISCAL Policy and
MONETARY Policy
•The policy of the government in which it utilizes its tax revenue and expenditure policy to influence
the aggregate demand and supply for products and services the economy is known as Fiscal Policy.
The policy through which the central bank controls and regulates the supply of money in the economy
is known as Monetary Policy.
•Fiscal Policy is carried out by the Ministry of Finance whereas the Monetary Policy is administered by
the Central Bank of the country.
•Fiscal Policy is made for a short duration, normally one year, while the Monetary Policy lasts longer.
•Fiscal Policy gives direction to the economy. On the other hand, Monetary Policy brings price stability.
•Fiscal Policy is concerned with government revenue and expenditure, but Monetary Policy is
concerned with borrowing and financial arrangement.
•The major instrument of fiscal policy is tax rates and government spending. Conversely, interest rates
and credit ratios are the tools of Monetary Policy.
•Political influence is there in fiscal policy. However, this is not in the case of monetary policy.

25. CRITICISM OF FISCAL POLICY
•Disincentives of Tax Gains and Cuts :
Increasing Taxes to reduce AD may cause discourage to work, if this occurs there will be a fall
in productivity and AS could fall. However higher taxes do not necessarily reduce
incentives to work if the income effect dominates.
•Side Effects on Public Spending :
Reduced govt. spending to Increase AD could adversely effect public services such as public
transport and education causing market failure and social inefficiency.
•Poor Information :
Fiscal policy will suffer if the govt. has poor information. E.g. If the govt. believes there is
going to be a recession, they will increase AD, however if this forecast was wrong and the
economy grew too fast, the govt. action would cause inflation.
•Time lags :
If the govt. plans to increase spending this can take along time to filter into the economy and
it may be too late. Spending plans are only set once a year. There is also a delay in
implementing any changes to spending patterns.
•Budget Deficit :
Expansionary fiscal policy (cutting taxes and increasing G) will cause an increase in the
budget deficit which has many adverse effects. Higher budget deficit will require higher
taxes in the future and may cause crowding out.

26. HIGHLIGHTS OF RELATIONSHIP
BETWEEN POLICIES
•Both are used to achieve macroeconomic objectives.
•Both influence output and interest rates.
•Helps to obtain optimum policy mix.
EXAMPLE :
•Prior to 1991 when economic reforms were initiated the basic goal of monetary policy was
to neutralize the impact of large fiscal deficits of the Government. To boost public sector
investment for accelerating economic growth there was large increase in Government
expenditure under various Five Year plans which was financed by borrowing by the
Government and deficit financing (i.e., monetization of budget deficit).
•Both Government borrowing from the market and deficit financing leads to the increase in
aggregate demand and have therefore potential for causing inflation. Therefore, to ensure
adequate funds to meet the borrowing requirements of the Government the statuary liquidity
ratio (SLR) of the banks was raised to the maximum limit of 38.5 per cent. That is, banks
were to buy government securities to this extent.
•Besides, to check inflation, cash reserve ratio (CRR) of banks was raised to a high level of
15 per cent. The high cash reserve leaves less funds with the banks to lend to the private
commercial sector. In this way large expansion of credit for private sector was prevented.

27. Which is more effective MONETARY or
FISCAL policy?
•Monetary policy is set by the Central Bank, and therefore reduces political influence whereas
Fiscal policy can have more supply side effects on the wider economy. E.g. to reduce inflation –
higher tax and lower spending would not be popular, and the government may be reluctant to
pursue this. Also, lower spending could lead to reduced public services, and the higher income
tax could create disincentives to work.
•Monetarists argue expansionary fiscal policy (larger budget deficit) is likely to cause crowding
out Expansionary fiscal policy (e.g. more government spending) may lead to special interest
groups pushing for spending which isn’t really helpful and then proves difficult to reduce when
the recession is over
•Monetary policy is quicker to implement. Interest rates can be set every month. A decision to
increase government spending may take time to decide where to spend the money.
•Monetary policy in a planned economy of India cannot be framed independently of fiscal policy
as achieving growth with price stability are the objectives of both these policies.
•In India the Reserve Bank of India has often adopted accommodative monetary policy to
Government’s fiscal policy.
.

28. FISCAL Policy In Action
Inflation
Real National Income
AS
AD
2.0%
U=5%
Assume an
initial
equilibrium
position with a
level of
National
Income giving
an
unemploymen
t rate of 5%
(U = 5%)
If government
‘reduces taxes’
(remember the
subtleties) and
or increases
spending, it will
have various
effects:
AD=C+I+G+(X-M)
Apart from G, C
and I are also
likely to be
affected directly or
indirectly by the
policy change.
AD 1
AD therefore
shifts to the
right to AD1
2.5%
U=3%
The rise in AD leads to
an increase in real
national income,
ceteris paribus,
unemployment would
fall to 3% but at a cost
of higher inflation

29. RBI's third bi-monthly policy statement,
2017-18
The Reserve Bank of India (RBI) on August 2, 2017 announced a 0.25 per cent cut in repo rate,
bringing it down to 6 per cent from the previous 6.25 per cent, the lowest in six-and-a-half years
since November 2010. The decision was taken by the six-member Monetary Policy Committee
(MPC) headed by RBI Governor Urjit Patel which held a two-day meet to deliberate on the bank's
stance on key policy rates.
Highlights of the RBI’s Monetary Policy Statement
* Key policy rate has been reduced by 0.25 per cent to 6 per cent.
* Reverse repo rate cut by 0.25 per cent to 5.75 per cent.
* Focus on keeping headline inflation close to 4 per cent on durable basis, the central bank said
* Some risks to inflation have reduced or not materialised, the RBI said
* Growth forecast remains unchanged at 7.3 per cent for the current fiscal.
* RBI pushes for reinvigorating private investments, clearing infra bottlenecks and providing big
thrust to PMAY.
* Forex reserves at USD 392.9 billion as on July 28.
* Four members of Monetary Policy Committee voted in favour of 0.25 pc rate cut.
* Farm loan waivers by states may result in fiscal slippages, undermine public spending quality, it
observed
* Government, RBI working to resolve large NPAs and recapitalise public sector banks, it said.

30. RBI's first bi-monthly policy statement,
2017-18
Liquidity :
The surplus liquidity in the banking system declined from a peak of around
Rs 7-lakh crore on January 4, 2017 to an average of Rs 6-lakh crore in
February and further down to Rs 4-lakh crore in March, the RBI said.

31. National fiscal policy response to the Great
Recession
•Beginning in 2008 many nations of the world enacted fiscal stimulus plans in
response to the Great Recession. These nations used different combinations of
government spending and tax cuts to boost their sagging economies
United States :
•In 2008 the United States Congress passed—and then-President George W. Bush signed—
the Economic Stimulus Act of 2008, a $152 billion stimulus designed to help stave off a
recession. The bill primarily consisted of $600 tax rebates to low and middle income
Americans.
•The United States combined many stimulus measures into the American Recovery and
Reinvestment Act of 2009, a $787 billion bill covering a variety of expenditures from
rebates on taxes to business investment. $184.9 billion was to be spent in 2009, and $399.4
billion was to be spent in 2010 with the remainder of the bill's appropriations spread over
the rest of the decade. Announcements of rescue plans were associated with positive returns
whereas a public intervention in favour of a specific bank showed negative impacts.

32. National fiscal policy response to the Great
Recession
China :
•A statement on the government's website said the State Council had approved a plan to invest
4 trillion yuan in infrastructure and social welfare by the end of 2010. This stimulus,
equivalent to US$586 billion, represented a pledge comparable to that subsequently
announced by the United States, but which came from an economy only one third the size. The
stimulus package will be invested in key areas such as housing, rural infrastructure,
transportation, health and education, environment, industry, disaster rebuilding, income-
building, tax cuts, and finance.
•China's export driven economy started to feel the impact of the economic slowdown in the
United States and Europe, and the government had already cut key interest rates three times in
less than two months in a bid to spur economic expansion.
•The stimulus package was welcomed by world leaders and analysts as larger than expected
and a sign that by boosting its own economy, China is helping to stabilize the world economy.
World Bank President Robert Zoellick declared that he was ‘delighted’ and believed that
China was ‘well positioned given its current account surplus and budget position to have fiscal
expansion.' News of the announcement of the stimulus package sent markets up across the
world.

33. National fiscal policy response to the Great
Recession
Germany :
•Compared to other European nations, Germany is in a unique position: It has low debt, a high
balance of trade, and an export driven economy. The recession has led to a decline in German
exports, but Germany has the capacity to replace some of the export demand with domestic
stimulus. The Germans were initially hesitant to pass a large stimulus bill; however, in 2009,
the Germans passed a 50bn euro stimulus bill that focused on taxes, a child tax credit, and
spending on transportation and education. Prior to the 2009 stimulus, one of Germany's largest
stimulus efforts had been a scrappage program. The German stimulus program includes a
"cash for clunkers" program that offers rebates of $3,172 to Germans who scrap their old cars
for new, more efficient models. The program totals about 5 billion euros.