Monetary Policy and Fiscal policy

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Monetary Policy and Fiscal policy:

Monetary Policy and Fiscal policy

What is monetary policy:

What is monetary policy Monetary policy is a tool used by the central bank to manage money supply in the economy in order to achieve a desirable growth . The central bank controls the money supply by increasing and decreasing the cost of money, the rate of interest.


MONETARY POLICY Meaning: In a Narrow Sense: Monetary Policy means monetary matters and decisions of a country which aim at controlling the volume of money, influencing the level of interest rates, public spending, use of money and credit etc. In Broader Sense: It includes all those monetary and non monetary measures and decisions which influence the cost and supply of money.

Forms of monetary policy:

Forms of monetary policy 1. Expansionary - Under an expansionary policy, policy makers increase the money supply in the system by lowering interest rates. This is done mainly to boost economic growth and decrease level of unemployment.

2. Contractionary :

2. Contractionary In contractionary policy, the cost of money is made dearer by increasing the rate of interest, which in turn helps in reducing the money supply in the system and combat inflation. Thus, while expansionary policy is followed to boost the economic growth, a contractionary policy is adopted to deal with an overheated economy situation.

Objectives of Monetary Policy:

Objectives of Monetary Policy Economic growth -increase capital formation Exchange stability -stability of balance of payment Full employement -increase production Price stability - to eradicate inflation and deflation. Credit control -increase and decrease interest rates Reduction in economic inequalities -distribution of income and wealth.


INSTRUMENTS OF MONETARY POLICY Supply of money Cost of money Availability of money a)Quantitative credit control 1. Bank Rate of Interest 2. Cash Reserve Ratio 3.Change liquidity ratio 4. Open market Operations 5. Deficit Financing b)Qualitative credit control Margin requirement of loans Rationing Direct action

Bank Rate of Interest:

Bank Rate of Interest It is the interest rate which is fixed by the RBI to control the lending capacity of Commercial banks . During Inflation , RBI increases the bank rate of interest due to which borrowing power of commercial banks reduces which thereby reduces the supply of money or credit in the economy .When Money supply Reduces it reduces the purchasing power and thereby curtailing Consumption and lowering Prices.

Cash Reserve Ratio:

Cash Reserve Ratio CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. During Inflation RBI increases the CRR due to which commercial banks have to keep a greater portion of their deposits with the RBI . This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation.

Statutory Liquidity Ratio:

Statutory Liquidity Ratio Banks are required to keep a given proportion of its deposits as cash with is called ‘liquidity ratio”

Deficit Financing:

Deficit Financing It means printing of new currency notes by Reserve Bank of India .If more new notes are printed it will increase the supply of money thereby increasing demand and prices. Thus during Inflation, RBI will stop printing new currency notes thereby controlling inflation.

Open market Operations:

Open market Operations It refers to the buying and selling of Govt. securities in the open market . During inflation RBI sells securities in the open market which leads to transfer of money to RBI.Thus money supply is controlled in the economy.

Fiscal policy:

Fiscal policy Fiscal Policy Fiscal policy is used by the governments to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment and economic growth.

Objectives :

Objectives Removal of unemployment -increases govt. expenditure and reduces taxes. Maintenance of economic development- increase the rate of capital formation Maintenance of price stability- reduce aggregate demand by reducing exp.and increasing direct and indirect taxes. Reduction in economic inequality- more taxes on rich

Instruments of Fiscal Policy:

Instruments of Fiscal Policy 1. Govt. Expenditure policy 2. Taxation policy 3. Deficit financing 4.Rationing 5. Public Debt policy 6. Pump priming-increase in investment of private sector through govt.

Other Measures :

Other Measures 1. Increase in Imports of Raw materials 2. Decrease in Exports 3. Increase in Productivity 4. Provision of Subsidies

Fiscal policy and inflation:

Fiscal policy and inflation 1.Decrease in public expenditure 2. Increase in public debts 3. Increases in taxes 4. Surplus budget policy-expenditure is less than its revenue

How is the Monetary Policy different from the Fiscal Policy? :

How is the Monetary Policy different from the Fiscal Policy? The Monetary Policy regulates the supply of money and the cost and availability of credit in the economy . It deals with both the lending and borrowing rates of interest for commercial banks. The Monetary Policy aims to maintain price stability, full employment and economic growth. The Monetary Policy is different from Fiscal Policy as the former brings about a change in the economy by changing money supply and interest rate, whereas fiscal policy is a broader tool with the government. The Fiscal Policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in government revenue and expenditure to influence the level of national output and prices.