Module-5

Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economics, this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation, increases employment and maintains a healthy value of money.

Fiscal policy basically means by which a government adjusts its levels of spending in order to monitor and influence a nation's economy. It refers to the union government's use of its annual budget to affect the level of economic activity, resource allocation and income distribution. The budget strategy can also influence the achievement of the government's objectives of internal and external balance and economic growth

The two main instruments of fiscal policy are government spending and taxation 1. The pattern of resource allocation; and 2. The distribution of income.

1. A neutral stance of fiscal policy implies a balanced budget where G = T (Government spending = Tax revenue). Government spending is fully funded by tax revenue. 2. An expansionary stance of fiscal policy involves a net increase in government spending (G > T) through a rise in government spending or a fall in taxation revenue or a combination of the two.

3. Contractionary fiscal policy (G < T) occurs when net government spending is reduced either through higher taxation revenue or reduced government spending or a combination of the two. This would lead to a lower budget deficit.

Interest payments Subsidies Capital Outlays Wages, Salaries and Pensions Defence

Taxation: I. Income Tax II. Witholding tax III. Sales tax IV. Stamp duty V. Capital gain tax VI. VAT

VII.Excise Duty VIII.Customs Duty Etc.

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.

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 below Statistics & Growth Graphs.

-7.2 11 (Re)

52 80

Rs. 345878 (Cr.)

26524 (US Million $)

11008 (US Million $)

12TH Largest Economy in the World as per GDP in US DOLLARS 3RD Largest Economy in the World as per GDP 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.

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

Navy is the fifth largest in the world.

Of the Fortune 500 companies, 220 outsource their Software-related work to India. There are over 70,000 Bank Branches in India - among the highest in the World.

BENCH SETTER: Indian Railways is the Largest Railway Network in the World under Single management employing just over 1.6 million employees Making it LARGEST EMPLOYER.

Fiscal deficit=Revenue receipts+recoveries of loans+other receipts- total expenditure. Revenue deficit =RR-RE Budgetary deficit =TR-TE Primary deficit= Fiscal deficit-interest payments

Monetary policy is the management of money supply and interest rates by central banks to influence prices and employment. It refers to those measures adopted by a central banking authorities, using credit policy and monetary policy to manage credit control. Monetary policy works through expansion or contraction of investment and consumption expenditure.

Price stability Stability of foreign exchange rate Full employment High rate of economic growth Equitable distribution of income

Monetary policy cannot change long-term trend growth. There is no long-term tradeoff between growth and inflation. (High inflation can only hurt growth). What monetary policy at its best can deliver is low and stable inflation, and thereby reduce the volatility of the business cycle.

When inflationary pressures build up:raise the short-term interest rate (the policy rate) which raises real rates across the economy which squeezes consumption and investment. The pain is not concentrated at a few points, as is the case with government interventions in commodity markets.

General/quantitative method Selective/qualitative method of credit control

Bank rate policy Open market operations CRR

Dear money policy Cheap money policy

It deals with buying and selling of securities by the central bank. It has direct influence on money circulation and cash reserve of the commercial banks. Central bank purchases securities when it wants to expand credit.

The central bank enjoys power to determine the statutory CRR of the commercial banks. The commercial banks has to maintain certain % of their demand and time deposits with the central bank as deposits.

Rationing of credit Direct action Variable margin requirement Regulation of consumer credit Moral suasion Deficit financing

The central bank may issue directions to commercial banks to restrict credit to certain sectors of the population. This method is particularly useful in controlling inflationary pressures.

It means the forceful measures adopted against those commercial banks which have committed errors.

VM is used to reduce speculation and hoarding activities by traders. The central bank rises the margin requirement. Ex.storing of food grains 50%-20lakhs,75%-20 lakhs

Regulation of consumer credit is resorted to only under severe inflationary conditions is an effort to restrict consumer demand for credit. Ex. Credit given for purchase of consumer durable goods may be charged very high rate of interest to discourage borrowing for this purpose by the consumer. This results in a fall of demand and there by fall in the price of goods.

MS is used by the central Govt. to put pressure on the lending activities of the commercial banks by using them to voluntarily adopt certain restrictive practices.

It is a method adopted to cover the budgetary gap by resorting to loans from the banks in developed countries. However in developing countries resort is made to 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 involves the increase in total money supply.since there is a creation of new money, it results in inflation and as a result the PP in the hands of the people increases, but the production of goods does not increase simultaneously.

Fixed by RBI M1 Narrow Money = Currency + Coins + Current Accounts M3 Broad Money = M1+Savings Deposits + Fixed Deposits + Post Office

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%

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

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 as 14 - 15% Inflation 3-6% in the last 3 years

Changing Reserve Ratios Bank Rate Open Market Operations

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

Net loans to central government (i.e. open market operations) Net purchase of foreign currency assets Change in cash reserve ratio Changes in repo rate and reverse repo rate Bank rate