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MONETARY AND FISCAL POLICY MATTER: IMPACT OF CROSS OVER

PARTHA BANERJEE ASST AUDIT OFFICER –CAG INDIA
Abstract - Monetary measure is more powerful tools whenever
we stepped over the Keynsian economic system into free-fall market economy.
The fiscal authority is still relevant especially at the time of severe market failure
reign. The ideal of independence of monetary and fiscal authority is essential in
order to flip around quasi equilibrium position. The excessive crossover of
authority in exercising power with one another’s floor ultimately detrimental for
natural rate of growth, interest rate determination and exchange rate issue with
consequence social indicators. Purposeful regulation of one another’s area of
operation shrinks the economic expansion even if external circumstances are
favorable.

Introduction –
Money supply and its circulatory control and expenditure for generation
of income and creation of public goods with maintenance are infinite process of
economy. To ensure balance in economic world two distinctive authorities is
accepted in modern economic regime one Fiscal Authority as the controller of
expenditure and budgeting with targeted resource allocation while on the other side
monetary authority through open market operation interest rate control money
supply mechanism plays role of controller of aggregate supply side of economy.
The equilibrium by force for one another is not at all equilibrium for aggregate
demand and supply. Ignoring one another’s inherent decisive freedom will bring
disequilibrium in disguise.

Distinctive Operatonal procedure.

Towards equilibrium both the policy plays a significant role since

IS curve is a aggregate demand of economy for good and service where as
overall supply of purchasing power known as supply represented by LM curve.
The controller of IS curve is the Elected Government by operation thorough
borrowing and taxing and incurring expenditure over budgeted expenditure
known as Fiscal policy and LM is operated with the direction of Apex bank of a
country through interest rate i.e repo rate and money supply namely monetary
policy.
Operation of expenditure out of really or expectedly available fund
through market operation taxing is source of Government hence fiscal source is
limited either due to practical limitation or political compulsion. The expenditure
target is to be set within given exchange rate , interest rate for a Fiscal policy
maker. As per sound fiscal policy no Government is given power to print money
for its expenditure such power only bestowed to the Apex bank. In India Section
22 of RBI Act 1934 specifically bestowed the apex body to do so. The fiscal
regime runs like extended household financial planning under given natural
interest rate with Government’s power to impose taxing for its source of
expenditure. The dichotomy likes in two edges. Collecting tax is plies adversely on
subjects of a Government whereas collecting tax is the only source for creation for
public goods. Though, borrowing option is presumably exists there but ultimately
it turns into tax burden in near future. In order to hide the explicit impact of
taxation Government many a times find its way through indirect taxation. In Indian
scenario over last 20 years proportion of indirect tax against direct tax remarkably
increase.(Rs in crore vertical axix)
4000000

3500000

3000000

2500000

2000000 centre___states_combinedi
ndirect
1500000 centre___states_combined
direct
1000000

500000

0
92 9 5 9 8 01 04 0 7 1 0 13 16 19
9 1- 94- 97- 00- 03- 06- 09- 12- 15- 18-
19 1 9 1 9 20 20 2 0 2 0 20 20 20

(TABLE 107 : DIRECT AND INDIRECT TAX REVENUES OF

CENTRAL AND STATE GOVERNMENTS GOI DATA)

Elected Government has political imperative to deliver less burden to

the electorate. Thus many a times the camouflaged burden is passed on which
remains behind the veil of public mind. Year’s data shows that in India indirect
taxation is a method to deliver burden without knowing the people how much
burden they bear. Burden of ever increasing indirect tax never brought as a
political issue by the opposition either state or central election. Increasing the
burden of indirect taxation is clearly regressive approach, since irrespective of
income level every person has to face the same consequences for same outcome. It
also implies source of direct taxation shrinking. This period is positively correlated
with the higher level of lending rate, thus those years with higher proportion of
indirect taxation relating to direct taxation has proportionately higher level of
lending rate. Single variable regression analysis exhibits the following regression
model where dependent variable is India’s central securities lending rate and
repressor is proportion of indirect income tax collection to direct tax collection

(Dependent variable Central securities lending rate whereas independent variable

indirect to direct tax collection ratio)

This regression clearly shows that the dependent variable

significantly dependent on the indirect to direct tax collection ratio.1 % change of
In-Direct to direct tax proportion would lead to change of 0.55 % change of
lending rate. This equation explains about 61 percent of the relation.
Further considering the following

(dependent variable is year wise gross fixed capital formation and regressor is
central securities lending rate of the year )
 In this equation taking central lending rate as dependent variable, it shows
gross fixed capital formation would be negatively impacted on gross capital
formation. Change of one percent rate wills negatively incidence on 2 percent of
gross capital formation, while on previous equation indirect taxation proportion
increase would lead to higher lending rate. Thus excess dependence of indirect
taxation would be somehow impact on low gross fixed capital formation. Under
this situation forceful turning back interest rate highly make shortage of capital
supply. The consequence evident instead of making fixed capital formation in
forced reduction of interest rate capital will flight away where easy withdrawal is
guaranteed in era of free movement of global capital.

Distinctive feature to be indulged

The area of operation of each segment is quite distinctive and that should
be because of single handed control approach would serve the policy makers self
interest unless cross balanced. Though impact of these two policy stands are on
same outcome but means of operation as well as point of action is quite different.
Proper coordination of two distinguished system might bring the desired economic
turnout. In absence of proper coordination short term equilibrium by forced
measure would usher costly outcome in medium term or long term. Free movement
of two policy measure, unless external shock comes within, it brings near
equilibrium point for medium to longer term. However, setting a very restraint
 monetary policy to offset for fiscal policy may crowd out private investment
significantly increase borrowing out of Government1

How crossover occurs

The need for quasi overlapping between two apparently distinct bodies is
absolutely possible since both are somehow dependent on each other. Fiscal
controller rather upholds greater power over monetary authority in democratically
elected Government mechanism, due to enactment of legislation for monetary apex
body is in the hand of Government. In spite of this, enactment gives provision for
free hand of both in order to keep pace with economic outcome. Towards obtaining
near equilibrium free movement of two bodies ultimately plays role of auto
corrected mechanism. The apex monetary authority is formed and doing its
function under the guideline of legislative process, while in the law regarding
decision on monetary regime is solely endured with such body. The political
activism sometimes takes over the function of monetary spaces by lobbying or
imposing influence either way in order to obtain short term political economic
gain. Determination of market interest rate is not under the ambit of fiscal
authority, rather their fiscal operation follow the free market determined rate in the
money market. Accordingly fixed coupon rate or Government savings rate is
declared. In pursuance of any of political gain the authority sometimes put its hand
in such determination; this is ultimately detrimental to the equilibrium of economy.
In modern economic regime of open parlance once interest rate is tried to framed
artificially immediate effect would bring disequilibrium on inflation, currency
value as well as real interest rate.

Legislation gives priority to fiscal authority

In India RBI Act ,1949 (Sec H) explicitly said that under sec 1(12AA) ;
dealing in Repo and Reverse repo that ultimately gives signal for open market
interest rate following margin for operational expenses. This sole responsibility is
very sensitive for national economy otherwise money market disequilibrium would
result determined interest rate would be a natural betrayal against natural rate.
Overburden of interest rate will be deprived off demand for capital expenses that
would downgrade supply of capital market the consequence would diverted into
fiscal into other fragile assets like bond or equity market for short to medium term.
The central bank will be primarily concern with the liquidity management with
11 IMF wp 9825-p-7
consequence of changes in Government cash balance whence the treasury is
responsible of managing cash balance. So to optimize cost of debt service
influencing the interest rate mechanism is lucrative area of Government, but the
same is detrimental for aggregate supply, due to natural reluctance of capital
supply at low rate.

Fiscal authority and political motive

Fiscal authority have natural motive for quantitative easing instead of
act of counter balancing of monetary policy to deliver the basic promise for
political commitment.. Politically elected Government might overstep in order to
get a millage by serving special interest group, primarily takes on interest rate
determination, but the same ultimately deter the natural growth rate of economy.
Influencing the interest rate by force, in open economy directly hurt the credibility
of currency, the exchange rate falls against hard currency of the world. Too
much lowering of interest rate would substantially harm the rate of growth, value
of currency and savings as well as supply of financial capital. Lowering the interest
rate against the natural rate would siphon the money into other fragile instrument,
may be legal or illegal. Capital flight is also major perilous step of owner under
this situation.
In a contrary situation weak Government may be under domination
monetary authority weakens its natural fiscal policy that keeps economy on the
wheel. The monetary authority, where no such discrimination is possible for both
separate authority, in order to fill the investment and income gap print money and
creates its abundance of liquid money stock. Very short term boost followed by
high inflation and stagflation consequently.

Experience so far
The repo rate mechanism is the strong tool for apex bank for determining
circulation of liquid money and substantial impact over money lending and deposit
savings rate for commercial and banking system. It should not be externally
influenced for political short term millage. Historical evidences many a times
exhibited the impact of over-controlled monetary decision how made collateral
damage. In his paper “Fiscal and Monetary Policy Interaction : Evidences and
Implication” for Inflation Targeting in Indonesia Firman Mochtar, depicted the
overcoming of crisis in Indenoesia made by limited overlapping of both the
authority with basic objective of financial stabilized growth. “For period after
1997, Granger causality test provides an insignificant figure. In addition to that
result, impulse response function of VAR system also obtained similar idea. The
response of public liabilities to primary surplus innovation provides an
insignificant impact, regardless the ordering. This result indeed slightly confirms
the QFA estimation that posed a deficit number since the crises occurred. These
results imply further description of fiscal and monetary policy interaction. The
period 1990-1997 indicates that the central Government has slightly succeeded to
pursue a debt management. Government has sufficiently reduced the future debt as
responses of primary budget surplus. The impulse response function in this period
indicated that a positive shock of current primary surplus has negatively affected
the future liabilities. Supporting the argument, QFA was also quite neutral such
that not sufficient enough to classify monetary policy as sub-ordinate of fiscal
policy. At some degree, the result of period 1990-1997 indicates that monetary
policy played dominant role with respect to fiscal and monetary policy interaction.
Nevertheless the story changed abruptly while the crises hit the mid of
1997.Although the lack of observation numbers may affect the story, the result
indicated a different portrait appeared. The sharp and huge depreciation of
domestic currency, big amount of issuing additional domestic debt and the
unavoidable liquidity support from central bank policy in 1997 – 1999
consecutively brought a big burden to fiscal policy such that also involved
monetary policy. This performance apparently indicates that fiscal policy play
more exogenously in this regime. Indeed, the study has also tried to exclude the
central bank securities to capture ‘real’ Government debt and to see its response to
the primary balance performance. However, the result does not change and keep
showing similar conclusion.”

Argentine economy shows that due to lack of authoritative monetary

authority during the period from 1991 after the fall of socialist regime till 2007 one
after another economic crisis came out. No fiscal or monetary authority all of
which is not timely action to equilibrate the position could shows the bright
morning. From devaluation of currency to tax cut, austerity measure nothing
worked at all. The stability approach in all time one way. There was seer lack of
monetary action in response to fiscal steps.
(https://www.jec.senate.gov/public/_cache/files/5fbf2f91-6cdf-4e70-8ff2-
620ba901fc4c/argentina-s-economic-crisis---06-13-03.pdf)

Concluding remarks

Towards stabilization no unilateral move is unanimously appropriate

for the all weather. Overemphasized fiscal standing during the post world war
 regime resulting in wasteful resource of public money with serious malfunction
policy of efficient public goods creation. Latter on post globalization era over
emphasizing on monetary policy lost finance capital on speculation bet or
inefficient and forceful finance capital supply. Static mode of equilibrium see the
equilibrium at consideration of its own, however, dynamism consider the others
premise over the time period. The dynamics lies in freehold movement of each and
acceptance of another one’s stand at equilibrium. The once equilibrium is not
equilibrium for all season, it may move towards north or south or by any other
direction , at this juncture rigidity at own move will widen the gap from
equilibrium.

Reference source
1. The Argentine Financial Crisis: Causes and Lessons Learned – Policy Perspectives (policy-
perspectives.org)

2. https://www.bing.com/search?
q=argentina+financial+crisis+fiscal+moetary+policy+conflictcvid=d44025ec10d8452bb62e7be559fca51a
&aqs=edge..69i57.14921j0j4&FORM=ANAB01&PC=U531

3. Data source – 1.world bank india data(India | Data (worldbank.org))

4. RBI data bank
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