Fiscal Policy & Monetary Policy

Session 07

Ranjan Kumar Mohanty

Xavier Institute of Management
Bhubaneswar (XIMB)
XIM University
 Effects of Fiscal Deficit

Investment,
Interest rate, https://doi.org/10.1007/s40953-020-00211-1
inflation, CAD Economic Growth
etc.
Kinds of Fiscal Policy: Responses to instability

Fiscal Policy

Non-
Discretionary
Discretionary

Anti- Anti-
Recessionary Inflationary Changes in Transfer
tax Revenues payment
Fiscal Policy Fiscal Policy
 Discretionary Fiscal Policy
Anti-
Recessionary
 1. Anti–Recessionary Fiscal Policy: Fiscal Policy
 Aggregate Demand Decreases
 Private Investment Fall Increase In
Reduction In
Govt
Taxes
 a) Increase In Govt Expenditure: How? Expenditure

1. Public Works Building roads, dams, ports, telecommunication links, irrigation works,
electrification of new areas etc…
2. Buying various types of goods and materials
3. Employing labor
What is going to be the effect?
▪ Direct Effect: Increase in Income of suppliers and sellers, Increase in demand for capital good
▪ Indirect Effect: Consumption Increases,
▪ Increase in demand for consumer goods,
▪ Generates Employment and Income
▪ National Income and output
 Discretionary Fiscal Policy
Anti-
Recessionary
 b) Reduction in Taxes: Fiscal Policy

 What is going to be the effect?

 Increase in the Disposable Income Increase In
Govt
Reduction In
Taxes
Expenditure
 Increase in Consumption
 Employment will increase
 National Income and output
 Leadto increase in “Budget Deficit” Need to be
financed by Borrowing or Creation of Money.
 Discretionary Fiscal Policy
Anti-
Inflationary

2. Anti–Inflationary Fiscal Policy: Fiscal Policy

 Aggregate Demand & Supply Mismatches

Reducing
 Private Investment Rises Govt
Increase In
Taxes
Expenditure
 a) Reducing Govt Expenditure: How?
 Reducing expenditure on non-development or unproductive heads like
Defense, police, military, subsidies, transfer payments etc.-Decrease in
income- fall in aggregate demand- reduction in inflationary gap.
 At the time of deflation (when aggregate demand is less than aggregate
supply) the government decides to increase its expenditure for the welfare of
the people.
 This injects money in the economy and helps remove unemployment and
increases the aggregate demand.
 It leads to reduction in deflationary gap.
 Discretionary Fiscal Policy Anti-
Inflationary
Fiscal Policy

Reducing
Increase In
Govt
Taxes
Expenditure
 b) Increasing Taxes:
 Reduces the disposable income- Consumption reduces- Aggregate
demand reduces.
 During the time of inflation (when aggregate demand is more than
aggregate supply) the government increases the tax rates and may
also impose new tax rates. This would result in reduction in the
money supply in the economy and will control the inflationary gap &
Vice-versa during deflation.
 Leads to increase in “Budget Surplus”
 Non- Discretionary Fiscal Policy

 Taxes and Expenditure vary automatically with changes in National Income.

 With built in stabilizers recession and inflation will be shorter and less
intense.
 1) Personal Income Taxes
 Direct relationship in between tax revenue and level of income
 Higher National Income, citizen have to pay higher taxes, which reduces the disposable
income and the consumption demand.
 Fall in national income in recession, lower taxes but aggregate demand does not fall.
 2) Corporate Income Taxes
 Companies pay percentage of profits as tax.
 Revenue rises during inflation which reduces aggregate demand.
 Revenue falls in recession which tend to offset the decline in demand.
 Non-Discretionary Fiscal Policy
 3) Transfer Payments ( Unemployment & Welfare benefits, subsidies,)
 It’s a fiscal instrument which redistributes income in favor of poor.
 In recession Transfer Payments increases, Govt Expenditure increases and increases aggregate demand
 In prosperity phase, transfer payments decreases, reduces demand and inflation.
 4) Corporate Dividend Policy
 Corporate follow a stable dividend policy
 Permits individual to spend more during recession
 Less during prosperity phase
 Success of this largely depend upon tax compliance, honest declaration of income, a stable
dividend policy and transparent economic system.
 Per cent
Per cent Per cent

-20
0
20
40
60

-10
0
10
20
30
40
50
0
20
40
60

-20
Manipur

0
Karnat… Maharash… Kerala
 What
Nagaland Punjab

0
Mahara…
Goa Sikkim

0
Punjab Kerala Tamil…
Himach…

0
Himach… Punjab
Sikkim Haryana

0
Kerala Telang…
Mizoram
 Depends

Mahar…

1
Bihar Tripura
Gujarat
Uttarakh…

1
Tamil… Uttarak…
Arunacha…

3
Jammu… Karnat…
Meghalaya
Manipur
West… Assam
Goa
Himachal…
Gujarat Andhra…
Haryana
Mizoram
Average Tamil Nadu Average
Haryana Gujarat Chhatti…
Chhattisg… Odisha
Rajasthan
Average Uttar…
Assam Jammu… Jammu…
Andhra… West Bengal West…
Telangana
Figure 1:Education Inefficiency_2018

Meghal…
Uttar… Andhra… Rajasthan
Karnataka Arunac…

11 16 17 24 24 25 26 28 32
Jharkh…
Madhya… Nagaland
Odisha
Rajasthan Tripura
0 0 0 0 0 0 0 2 5 6 1212141517212324 3232 3435 363738 42

Figure 5:Information and Broadcasting Inefficiency_2018

Figure 3:Water Supply and Sanitation Inefficiency_2018

Uttarak… Bihar Madhy…

Bihar
0 0 0 0 0 0 0 0 1 1 1 1 2 3 3 7 7 7 10 12 12 13 16 16 23 26 33 34

Madhy… Jharkhand
Assam
45 47 48

Uttar…

37 38 40 40
Chhatti… Jharkh…
52

38 45

Odisha

Per cent
Per cent Per Cent
-20
0
20
60
40
0
40
60
80

20

0
20
40
60

Assam
Gujarat Himacha…
Policy Option

Goa
Kerala Karnataka
Punjab
Mizoram Kerala
Madhya…
Punjab Maharas…
Tripura
Goa Mizoram
Bihar
Manipur Nagaland
Nagaland
Sikkim Sikkim
Himachal…
Tripura Arunach…
Odisha Uttarakh…
Himac…
Maharashtra Gujarat
Jamm…
Sikkim Haryana
Nagala…
on the efficiency of Public Sector

Rajasthan Goa
Tamil…
Kerala Jammu…
Telang…
Average Punjab
Average
Uttar… Tamil…
Aruna…
West Bengal Tripura
0 0 0 0 2 3 13 17 18 19 20 26 27 29 29 33

Andhr…
Tamil Nadu West… Telangana
Telangana Mahar… Average
0 0 0 0 0 5 9 11 15 20 21 22 22 24 26 27 28 28 29

Meghalaya Uttara… Rajasthan

Karnataka Odisha Chhattis…
Andhra…
0 0 0 0 0 0 4 4 14 15 16 17 18 19 20 24 26 26 31 35 38

Haryana Odisha
Figure 2:Health Inefficiency_2018

Mizoram Assam Manipur

Chhattisgarh Karna… Madhya…
Haryana
Figure 6:Rural Development Inefficiency_2016

Chhatt… West…
Jharkhand Megha… Meghalaya
30 30 35 36 38 39 39

Gujarat
Figure 4:Social Welfare and Nutrition Inefficiency_2015

Andhra…
37 37 38 39 40 40 45 45 46 47

Rajast…
Manipur
42 43 46 49 55 55

Uttar… Assam
Arunachal… Madhy… Jharkhand
Jammu… Bihar Uttar…
41 43 43 46

Uttarakhand
55 63 65

50 51 54 55

Jhark… Bihar
is better Govt Expenditure or Taxes for stabilization?
 Per cent Per cent
Per cent

0
50
100

-20
0
100

20
40
60
80
-50
100

0
50


Kerala Kerala
Arunachal…
Gujarat West Bengal
Haryana
Karnataka Gujarat
Nagaland
Madhya… Tamil…
Punjab
Rajasthan Maharashtra
Tripura
Mizoram Uttarakhand
Tamil Nadu Rajasthan
Uttar…
Andhra…
Chhattisgarh
Bihar

0 0 0 0 0 0 9 243031
Uttar Pradesh Telangana
Tamil Nadu
Odisha Sikkim
Andhra…
Uttarakhand Karnataka
Andhra… Average
Gujarat
Mizoram
West Bengal
Chhattisgarh
444546 47 56 57

Himachal… Sikkim
Jharkhand

are better options.

Telangana Meghalaya
Assam
Bihar Madhya…
Average Telangana
Jammu…
Haryana
Punjab
Manipur
0 0 0 0 0 3 6 7 18 27 28 38 39 39 47 49 53 53 54 54 56 57 57

Nagaland Manipur
Uttar Pradesh
Sikkim Assam
Figure 9:Roads Transport Inefficiency_2016

6365 65 66666667 69

Chhattis…
Goa Tripura
Maharashtra Odisha
Karnataka
Figure 7:Irrigation and Flood Control inefficiency_2017

Kerala
Figure 11:Police Inefficiency_2018

Jammu… Jammu…
Haryana Jharkhand
Goa
64 67 69 69 69 70 79

Himachal…
74 7980 8283 84

Tripura
Jharkhand
Arunachal…
0 0 0 0 1 2 3 4 11 11 12 14 14 16 19 19 20 20 20 20 21 23 24 24 28 36 40 48

Assam
57

Meghalaya
Per cent Per cent
80

Manipur
-50
0
100

50

-20
0
20
40
60

Chhattisgarh Kerala
Sikkim
Policy Option

Karnataka
Kerala Goa
Manipur Punjab
Andhra… Uttarakha…
Telangana Gujarat
Bihar Telangana
Jammu… Haryana
Nagaland Himachal…
Meghalaya Tamil Nadu
Maharashtra Maharash…
West Bengal Andhra…
Tamil Nadu Karnataka
Arunachal… Chhattisg…
Mizoram Average
Average Jammu…
Uttar Pradesh Rajasthan
Rajasthan Madhya…
0 0 0 0 0 4 12 13 16 21 28 34 35 38 43 49 50 53 54

Assam Tripura
Tripura Odisha
Figure 8:Energy Inefficiency_2018

Haryana Meghalaya
Figure 10:Public work inefficiency_2018

Punjab Arunacha…
West Bengal
0 0 0 0 0 0 3 6 7 9 10 12 13 18 20 20 24 24 24 26 27 29 31

Jharkhand
Himachal… Mizoram
62 65 69 71 72 75

Uttarakhand Uttar…
Madhya… Nagaland
32 37 38 38

Odisha Manipur
 Also depends upon the magnitude of effect of Expenditure and Tax Multiplier.

Goa Assam
43 46

Gujarat Jharkhand
84 85 86 89 89

57

Sikkim Bihar
https://doi.org/10.4337/9781839109164.00026

Public sector are inefficient and involves waste of scarce resources then Taxation
 Practice Questions
1. During a recession, which of the following is likely to occur?
a. an increase in real wages
b. an increase in production
c. and increase in the GDP growth rate
d. an increase in the unemployment rate
Answer: d
2. Taxes that are levied on any Intra-State purchase are?
a. IGST
b. CGST and SGST
c. SGST
d. UTGST
Answer: b
3. Pick out the factor which is not a demerit of indirect taxes.
a) Unjust to poor
b) Inflationary in nature
c) A tool of economic policy
d) High administrative cost
Answer: c
4. Which one of the following body will decide the tax rates for goods and services under GST regime?
a. Central and State government
b. Finance Commission
c. NITI Aayog
d. GST Council
Answer: d
ACTIVE LEARNING : Fiscal Policy Effects
The economy is in recession.
Shifting the AD curve rightward by $600b would end the
recession.
A. If MPC = .75 and there is no crowding out, how much
should Indian Government increase G to end the
recession?
Multiplier = 1/(1 – .75) = 4
Increase G by $125b
to shift agg demand by 4 x $125b = $600b.
 Monetary Policy &
Economic Environment
 Session Learnings

• Objectives of Monetary Policy

• Instruments of Monetary Policy & their Mechanism
•Types of Monetary Policy
• Monetary Policy Framework
• Monetary Policy Transmission Mechanism

15
 Basic Concepts
 Functions of Money
 Medium of exchange, store of value, unit of account, differed payment
 Demand for Money
 Transaction, precautionary and Speculative
➢ Supply of Money
➢ M0, M1, M2, M3
➢ M0 (Reserve Money)= Currency in circulation + Bankers’
deposits with the RBI + ‘Other’ deposits with the RBI
➢ M1= Currency with the public + Demand deposits with the
banking system + ‘Other’ deposits with the RBI.
➢ M2= M1 + Savings deposits of post office savings banks
➢ M3= M1 + Time deposits with the banking system
➢ Money Multiplier
➢ Liquidity Trap
Thank you