MONETARY POLICY

Monetary policy is the policy statement, traditionally biannual , through which the RBI targets a key set of indicators to ensure price stability in the economy.

These factors include : money supply Interest rate Inflation

RBIs monetary policy has been characterized as one of controlled expansion ie., adequate financing of economic growth and the same time , ensuring reasonable price stability.

Before initiating measures for the expansion or contraction of money supply, the RBI generally measures the extent of money and credit available in the economy at a given time.

Indices to measure money and credit

M1: This represents money supply with the public. M1 has two components: (a) currency with the public (b) deposits of the public with the banks Currency with the public is the sum total of notes in circulation and circulation of rupee coins and small coins minus the cash on hand with banks. Deposits of public with banks is the sum total of demand deposits with banks and other deposits of the public with the RBI.

M2 : this represents the total of M1 plus post office savings and bank deposits M3: It is the sum total of M2 and the time deposits with bank. M4 : this represents M3 plus total post office deposits. M1 is called narrow money while M3 represents aggregate monetary resources of the money stock of the entire banking sector . REPRESENTATIVE SOURCES OF M3: A) The net bank credit to the government B) Bank credit to the commercial sector C) Net foreign exchange assets of the banking sector D) The government currency liabilities to the public

Definition Monetary Policy

By monetary policy we mean the regulation of the money supply and the control of the cost and availability of credit by the central bank of the country through the use of deliberate and discretionary action for achieving the objectives of general economic policy.

Monetary Policy-- Objectives

1. Maximum feasible output 2. High rate of economic growth 3. Fuller employment 4. Price stability 5. Greater equity in the distribution of income and wealth 6. Healthy balance of payments. Gupta opines that When monetary policy is conducted with a view to long-run price stability at maximum feasible output, other goals of economic policy viz fuller employment, a high rate of growth, greater equality and healthy balance of payments are also promoted to the maximum extent

EXPANSION: Money is pumped into the economy trough the issue of currency by the RBI, budgetary operations of the government and borrowings by the government from foreign countries. Expansion is always encouraged in a country, infact, the growth in money supply must be higher than the growth in the real national income. This stems from to two reasons. a) As income grow, the demand for money as one of the components of savings trends to increase b) An increase in money supply is also necessitated by the gradual reduction of non-monetised sector of the economy

Expansion and Contraction of Money

But in our country the rate of increase in money supply has been far in excess of the rate of growth in real national incomes. Hence inflationary pressure is there on economy. CONTRACTION: Unlimited expansion of money and credit results in hyperinflation, which hits all sections of society, particularly the poor. The RBI has a responsibility to ensure that money is within manageable limits and inflation is not too harsh. For this purpose , the RBI has been using different control measures, called credit control measures. (A)General (quantitative ) controls (B) Selective (qualitative) controls

GENERAL CREDIT CONTROLS

(i) BANK RATE Bank rate: also called discount rate, bank rate refers at which the Central Bank rediscounts or lends money to commercial banks. During inflationary periods, the bank rate is hiked so as to increase the rate of interest on borrowings. The reverse course of action is taken during the periods of falling prices. Change in bank rates by RBI
1965 1973 1974 6% 7% 9%

1983
1991 2000 2003

10%
11% - 12% Reduced to 8% Cut down to 6%

A) Open Market Operations : refers to purchase or sale of securities, foreign exchange and gold by the government. Purchase of securities and gold from public results in extension of money. Sale of securities and gold results in contraction of money supply. B) Special Facilities to Some Groups: the Reserve Bank advices commercial banks to advance liberally to special groups like Small-Scale-industries, cooperatives , small transport operators, self employed etc., .This also results in expansion of money.

c) Liberalisation of the Bill Market Scheme: under this, commercial banks get additional finance from the Reserve Bank. With additional funds at their disposal, commercial banks will be able to advance credit further. D) Development Banks: since Independence , the RBI has setup a series of development banks like IFCI, IDBI etc., through which funds are available to finance economic activities.

(ii) CASH RESERVE REQUIREMENTS (CRR) Under the RBI Act 1935, every commercial bank has to keep certain minimum cash reserve with the RBI. The RBI is empowered to vary the CRR between 3 percent and 15 percent of demand and time deposits. CRR was changed over time: 1973 7% CRR is a powerful 1984 9% weapon
1987 1991 1994 Increased by 0.5% Hiked to 15% Decreased to 14%

1997
1993 june onwards

Cut down to 10%

4.5 %

(iii) STATUTORY LIQUIDITY RATIO (SLR) In addition to CRR, every commercial bank should keep a certain percentage of its total demand and time deposits with the RBI in the form of liquid assets like cash, gold etc., Maintenance of adequate liquid assets is a basic principle of sound banking. As per the Banking Regulation Act 1949 the commercial banks need to maintain a minimum ratio of liquid assets.The RBI has empowered to change the ratio.
1972 1973 1981 Raised from 25% to 30% 32% 35%

1984
1987 1991

36%
37.5% Raised to 38.5% & reduced to 25%

(iv) REFINANCE POLICY The system of refinance provide by the RBI to commercial banks affects their credit. The system is changed periodically to allow or disallow certain flows by the banks. The scope of refinance as an instrument of credit controls depends on the liquidity position of the commercial banks. Over the years, the commercial banks dependence on the RBI for refinance has come down except in the case of subsidised refinance of agriculture and rural credit. The effectiveness of refinance policy has therefore come down.

SELECTIVE CREDIT CONTROLS

Selective credit controls affect particular sectors of the economy and the include such measures as: (i) Insisting on minimum margins for lending against specific securities; (ii) Fixing ceiling on the amounts of credit for certain purposes; (iii) Charging discriminatory rates of interest on certain types of advance; (iv) Moral suasion; RBI appeals to the good sense of banks not to do or do certain things (v) Direct action ; refusal BY Reserve Bank to rediscount bills of a particular commercial bank which has failed to comply the directives of the former.(cancellation of license)

An Evaluation of Monetary Policy

The inability of the Reserve Bank to deny or regulate credit to the Central Government due to both legal and practical considerations has been interpreted by the committee( Sukhamony Chakravarthy Committee) as an important factor in the Reserve Banks helplessness in controlling the rise in money supply. With regard to the role of RBI in controlling inflation, criticism is equally strong. It is said that the monetary policy operated by the RBI did not play any effective role in containing inflation in the economy.

WEAKNESS
Higher proportion of nonbanking credit No check on price

STRENGTH
Decision making and implementation is faster than fiscal policy

High currency-deposit ratio More reliance on selective rendering the RBIs role less credit control measures and effective less on quantitative controls making RBIs pressure on commercial bank less severe Selective application of credit constraint Defective statistical and monetary system Has been responsive to the needs of the economy

Growing fiscal needs to the economy

FISCAL POLICY

FISCAL POLICY What does mean by fiscal policy? FISC denotes public treasury and the fiscal policy indicates how the government attempts to realize revenue, spending and managing the deficit. In short fiscal policy tells the methods adopted by the government in taxation , public expenditure and public debt.

DEFINITION: According to Prof. R.Lipsey and Prof.Peter Teiner, Fiscal policy is defined as the conscious attempt of the government to achieve certain macro economic goals of policy by altering the volume and pattern of its revenues and expenditures and the balance between them. The major economic goals of fiscal policy are to maintain a high average level of employment and business activity, to minimize fluctuations in employment activity, prevent inflation & to produce and promote economic growth

The major economic goals of fiscal policy are to maintain a high average level of employment and business activity, to minimize fluctuations in employment activity, prevent inflation & to produce and promote economic growth

Fiscal policy operates through the budget. In fact, fiscal policy is also known as budgetary policy. The budget means an estimate of revenue and expenditure. Fiscal policy denotes the use of taxes and government expenditure: Government expenditures----- two distinct forms (i) Government purchase: comprise spending on goods and services--- purchase of tanks, construction of roads, salaries for judges etc., (ii) Government transfer payments, which boost the incomes of targeted groups such as elderly or unemployed . Government expenditures also effect the overall level of spending in the economy & thereby influence the level of GDP.

Taxation: Taxation affects the overall economy in two ways: (i) Taxes affect peoples income , taxes tend o affect the amount people spend on goods/services as well as the amount of private saving
(i) Taxes affects the prices of goods & factors of production for example more heavily business profits are taxed, the more business are discouraged in new capital goods.

Fiscal Policy
Fiscal policy refers to the policy of the government regarding taxation, public expenditure and public debt. Governments all over the world have been using fiscal measures to regulate their economic and business activities in order to achieve such objectives as: Accelerating the rate of investment Promoting socially desirable investments Achieving rapid economic development Achieving full employment Promoting foreign trade Reducing inequalities of income Establishing a welfare state

Keynes argued for intervention by the government to cure depression and inflation by adopting appropriate tools of macroeconomic policy ie., fiscal policy and monetary policy.