Unit 4 & 5 – Macro Economics & Inflation,

Monetary & Fiscal Policy

Macroeconomic objectives
Broadly, the objective of macroeconomic policies is to maximize the level of national
income, providing economic growth to raise the utility and standard of living of
participants in the economy. There are also a number of secondary objectives which are
held to lead to the maximization of income over the long run. While there are variations
between the objectives of different national and international entities, most follow the
ones detailed below:
1. Sustainability - a rate of growth which allows an increase in living standards
without undue structural and environmental difficulties. 'Economic growth' will be
studied later on in this book.
2. Full employment - where those who are able and willing to have a job can get one,
given that there will be a certain amount of frictional, seasonal and structural
unemployment (referred to as the natural rate of unemployment).
3. Price stability - when prices remain largely stable, and there is not rapid inflation
or deflation. Price stability is not necessarily the same as zero inflation, but instead
steady levels of low-moderate inflation is often regarded as ideal. It is worth noting
that prices of some goods and services often fall as a result of productivity
improvements during periods of inflation, as inflation is only a measure
of general price levels. However, inflation is a good measure of 'price stability'. Zero
inflation is often undesirable in an economy.
4. External Balance - equilibrium in the Balance of payments without the use of
artificial constraints. That is, the value of exports being roughly equal to the value of
imports over the long run.
5. Equitable distribution of income and wealth - a fair share of the national 'cake',
more equitable than would be in the case of an entirely free market. Like the other
economic objectives, the distribution of income is a partly subjective or normative
issue
6. Increasing Productivity - more output per unit of labour per hour. Also, since
labor is but one of many inputs to produce goods and services, it could also be
described as output per unit of factor inputs per hour.
7. Trade Equilibrium - equilibrium in the Balance of payments without the use of
artificial constraints. That is, exports roughly equal to imports over the long run.

Economic Theory - Prof Charmi Gala 1

Monetary Policy
Monetary policy is the policy through which the central bank of any country controls the
economy of the country. When the cash demand of a country is estimated, the central
bank issues paper money. This circulation of paper money needs to be managed and kept
stable, and that is where monetary policies come into play.
This is done because money is a medium of exchange when related to the supply of
goods. Thus, the central bank uses various instruments to maintain and contribute to the
economic growth of the country.

Objectives of the Monetary Policy of India

1. Price Stability: Price Stability implies promoting economic development with
considerable emphasis on price stability. The centre of focus is to facilitate the
environment which is favourable to the architecture that enables the developmental
projects to run swiftly while also maintaining reasonable price stability.
2. Controlled Expansion Of Bank Credit: One of the important functions of RBI is the
controlled expansion of bank credit and money supply with special attention to the
seasonal requirements for credit without affecting the output.
3. Promotion of Fixed Investment: The aim here is to increase the productivity of
investment by restraining non-essential fixed investment.
4. Restriction of Inventories: Overfilling of stocks and products becoming outdated due
to excess stock often results in the sickness of the unit. To avoid this problem the central
monetary authority carries out this essential function of restricting the inventories. The
main objective of this policy is to avoid over-stocking and idle money in the organization
5. Promotion of Exports and Food Procurement Operations: Monetary policy pays
special attention in order to boost exports and facilitate trade. It is an independent
objective of monetary policy.
6. Desired Distribution of Credit: Monetary authority has control over the decisions
regarding the allocation of credit to priority sector and small borrowers. This policy
decides over the specified percentage of credit that is to be allocated to the priority sector
and small borrowers.
7. Equitable Distribution of Credit: The policy of the Reserve Bank aims equitable
distribution to all sectors of the economy and all social and economic classes of people
8. To Promote Efficiency: It is another essential aspect where the central banks pay a lot
of attention. It tries to increase the efficiency in the financial system and tries to
incorporate structural changes such as deregulating interest rates, easing operational
constraints in the credit delivery system, introducing new money market instruments etc.
9. Reducing the Rigidity: RBI tries to bring about the flexibilities in the operations which
provide considerable autonomy. It encourages a more competitive environment and
diversification. It maintains its control over the financial system whenever and wherever
necessary to maintain the discipline and prudence in operations of the financial system.

Economic Theory - Prof Charmi Gala 2

Instruments of quantitative measures:
1. Bank rate − The rate at which central bank provides loan to commercial banks is called
bank rate. This instrument is a key at the hands of RBI to control the money supply.
Increase in the bank rate will make the loans more expensive for the commercial banks;
thereby, pressurising the banks to increase the rate of lending. The public capacity to take
credit will gradually fall leading to the fall in the volume of credit demanded. The reverse
happens in case of a decrease in the bank rate. The increased lending capacity of banks as
well as increased public demand for credit will automatically lead to a rise in the volume of
credit.
2. Varying reserve ratios
The reserve ratio determines the reserve requirements, wherein banks are liable to
maintain reserves with the central bank.
The three main ratios are:
(i) Cash Reserve Ratio (CRR)
It refers to the minimum amount of funds that a commercial bank has to maintain with the
Reserve Bank of India, in the form of deposits. For example, suppose the total assets of a
bank are worth Rs.200 crores and the minimum cash reserve ratio is 10%. Then the amount
that the commercial bank has to maintain with RBI is Rs.20 crores. If this ratio rises to 20%,
then the reserve with RBI increases to Rs.40 crores. Thus, less money will be left with the
commercial bank for lending. This will eventually lead to considerable decrease in the
money supply. On the contrary, a fall in CRR will lead to an increase in the money supply.
(ii) Statuary Liquidity Ratio (SLR)
SLR is concerned with maintaining the minimum reserve of assets with RBI, whereas the
cash reserve ratio is concerned with maintaining cash balance (reserve) with RBI. So, SLR is
defined as the minimum percentage of assets to be maintained in the form of either fixed
or liquid assets with RBI. The flow of credit is reduced by increasing this liquidity ratio and
vice-versa. In the previous example, this can be understood as rise in SLR will restrict the
banks to pump money in the economy, thereby contributing towards decrease in money
supply. The reverse case happens if there is a fall in SLR, as it increases the money supply
in the economy.
Economic Theory - Prof Charmi Gala 3
3. Open Market Operations (OMO)
Open Market operations refer to the buying and selling of securities in an open market, in
order to affect the money supply in the economy. The selling of securities by RBI will wipe
out the extra cash balance from the economy, thereby limiting the money supply, whereas
in the case of buying securities by RBI, additional money is pumped into the economy
stimulating the money supply.

Qualitative Measures
The measures that affect the credit qualitatively are
1. Marginal Requirements
The commercial banks’ function to grant loan rests upon the value of security being
mortgaged. So, the banks keep a margin, which is the difference between the market value
of security and the loan value. For example, a commercial bank grants loan of Rs.80,000
against security of Rs.1,00,000. So, the margin is calculated as 1,00,000 − 80,000 = 20,000.
When the central bank decides to restrict the flow of money, then the margin requirement
of loan is raised and vice-versa in the case of expansionary credit policy.
2. Selective Credit Control (SCC’s)
An instrument of the monetary policy that affects the flow of credit to particular sectors
positively and negatively is known as selective credit control. The positive aspect is
concerned with the increased flow of credit to the priority sectors. However, the negative
aspect is concerned with the measures to restrict credit to a particular sector.
3. Moral Suasions
A persuasion technique followed by the central bank to pressurise the commercial banks
to abide by the monetary policy is termed as moral suasion. This involves meetings,
seminars, speeches and discussions, which explains the present economic scenario and
thereby persuading the commercial banks to adapt the changes needed. In other words,
this is an unofficial monetary policy that exercises the power of talk.

Fiscal Policy Meaning

Fiscal Policy refers to the use of government spending and tax policies to affect
macroeconomic conditions, particularly employment, inflation, and macroeconomic
variables such as aggregate demand for goods and services. These actions are primarily
intended to stabilize the economy. To accomplish these macroeconomic objectives, fiscal
and monetary policy actions are usually combined.

Everything relating to the government’s income and expenditures is covered under Fiscal
Policy. The most significant aspects of the economy are addressed through fiscal policy
measures, which range from budgeting to taxation. The three components of fiscal policy
in India are as follows. Public Debt, Government Expenditures, and Government Revenues.

Economic Theory - Prof Charmi Gala 4

Fiscal Policy Objectives
Objectives of Fiscal Policy
Fiscal policy is the use of taxation and spending by the government to affect a nation’s
level of economic activity. Governments employ fiscal policy to accomplish a number of
economic goals, such as:
Infrastructure Development
• In order to achieve economic growth, the government has prioritized infrastructure
construction. Taxation and other fiscal policy initiatives bring in money for the state.
The development of the infrastructure is funded in part by tax money. All economic
sectors benefit as a result of this.
Decreasing the payment deficit
• Fiscal measures like the exclusion of income tax on export revenues, the exclusion
of central excise charges and customs, the exclusion of sales tax and octroi, etc. are
all attempts by fiscal policy to increase exports.
• The balance of payments problem is helped by the foreign exchange saved through
import substitutes and earned through exports. In this method, a negative balance
of payments can be fixed by taxing imports or by subsidizing exports.
Effective Regional Development
• Balanced regional development is one of the fiscal policy’s other primary goals. The
government offers a variety of incentives for establishing projects in
underdeveloped areas, including cash subsidies, Tax holidays are a type of tax and
duty concession. financing with lowered interest rates, etc.
Price Stability and Control of Inflation
• Controlling inflation and maintaining price stability is one of the fiscal policy’s
primary goals. As a result, the government always strives to keep inflation under
control through the reduction of fiscal deficits, the introduction of tax savings plans,
the efficient use of financial resources, etc.
Complete Employment
• Employment should be the top priority in every nation that needs to better its
economic situation. India has the highest number of young people, which increases
the likelihood of development. The younger generation is more capable than the
older generation in several areas. Therefore, if our nation could offer full or almost
full employment, it would elevate our economic statistics to the next level. The
Fiscal policy guides all choices pertaining to employment. The government creates
more job opportunities in a number of different ways.
Economic Growth
• Specific fiscal policy initiatives can boost the nation’s growth rate and aid in
meeting its needs. The establishment of heavy industries like steel, chemicals,
fertilisers, and industrial machinery is one way the government promotes economic
growth. It also builds infrastructures that support economic development, including
roads, bridges, railways, schools, hospitals, water and electricity supplies,
telecommunications, and so forth

Economic Theory - Prof Charmi Gala 5

Economic Theory - Prof Charmi Gala 6
Inflation
https://www.investopedia.com/terms/i/inflation.asp

https://www.investopedia.com/terms/d/demandpullinflation.asp

https://www.investopedia.com/terms/c/costpushinflation.asp

https://www.investopedia.com/terms/c/consumerpriceindex.asp

https://www.investopedia.com/terms/w/wpi.asp

Students need to study this topic via these links

Economic Theory - Prof Charmi Gala 7

 National Income

Economic Theory - Prof Charmi Gala 8

Economic Theory - Prof Charmi Gala 9
Economic Theory - Prof Charmi Gala 10
Economic Theory - Prof Charmi Gala 11
Economic Theory - Prof Charmi Gala 12
Economic Theory - Prof Charmi Gala 13