Macroeconomic Policies

Monetary
policy & Fiscal policy
Macroeconomic policy goals
Macroeconomic policy is concerned with the operation of the
economy as a whole. In broad terms, the goal of macroeconomic
policy is to provide a stable economic environment that is
conducive to fostering strong and sustainable economic growth, on
which the creation of jobs, wealth and improved living standards
depend. The key pillars of macroeconomic policy are: fiscal policy,
monetary policy and exchange rate policy.
The major macroeconomic policy goals are:
• Economic growth
• Price stability
• Employment
• Balance of payments stability
 Macro economic policies
• Monetary policy (Central bank/RBI):Monetary policy consists of
management of money supply and interest rates, aimed at
achieving macroeconomic objectives such as controlling inflation,
consumption, growth, and liquidity. These are achieved by actions
such as modifying the interest rate, buying or selling government
bonds, regulating foreign exchange rates, and changing the
amount of money banks are required to maintain as reserves.

• Fiscal policy (Government):Fiscal policy refers to the use of

government spending and tax policies to influence economic
variables, including demand for goods and services, employment,
inflation, and economic growth.
 Types of Monetary Policy
Expansionary
• Central banks use  • Central
expansionary monetary policy to
lower unemployment and avoid 
recession. They increase liquidity by
giving banks more money to lend.
Banks lower interest rates, making
loans cheaper. Businesses borrow
more to buy equipment, hire
employees, and expand their
operations. Individuals borrow
more to buy more homes, cars, and
appliances. That increases demand
 and spurs economic growth.
Contractionary
banks use 
contractionary
monetary policy to reduce
inflation. They reduce the
money supply by restricting
the amount of money banks
can lend. The banks charge a
higher interest rate, making
loans more expensive. Fewer
businesses and individuals
borrow, slowing growth.
Instruments of Monetary policy
Quantitative Qualitative

Bank rate Change in marginal

requirements of loans
Cash reserve ratio(CRR)
Rationing of the money supply
Repo rate and Reverse repo
rate
Moral persuasion
Statutory liquidity ratio(SLR)
Publicity
Open market operations
Regulation of Consumer’s
Marginal standing
money supply as a loan
facility(MSF)
Market stabilization schemes Direct actions
(MSS)
 Bank rate
• It is known as discount rate.
• A rate at which RBI lends to
the commercial banks or RBI
rediscounts their bills.
• If bank rate is increased then
commercial banks will also
charge higher interest rates
on loans and this will lead to
credit contraction in the
economy. Commercial
• The current bank rate is banks
5.40% (March,2020)
 Cash reserve ratio
• CRR is a certain
percentage of bank
deposit which banks are
required to keep with RBI
in the form of reserves or
balance.
• Higher the CRR lower will
be the liquidity in the
system and vice-versa.
• The current CRR is 4%
(March, 2020)
 Statutory liquidity ratio (SLR)
• It means a certain
percentage of deposits
are to kept by banks
itself in the form of
liquid assets which
includes, Government
securities, treasury bills
and other securities
referred by the RBI.
• The current SLR is
18.25%( March,2020)
 Repo rate & Reverse repo rate
• Repo rate is that rate at which RBI
lends to commercial banks
generally against govt. Securities.
Reverse repo rate is the rate at
which RBI borrows money from
the commercial banks.
• As the rates are high the
availability of credit and demand
decreases resulting to decrease in
inflation. This increase in rates is a
symbol of tightening of the policy.
• The current Repo rate is 5.15% &
Reverse repo rate is 4.90%
(March,2020)
 Open market operations
• It means that the bank
controls the flow of credit
through the sale and
purchase of securities in
the open market.
• When securities are
purchased by RBI it
increases money supply
with commercial banks and
public. This will expand
credit in the economy.
 Marginal standing facility
• Marginal Standing Facility is a new Liquidity
Adjustment Facility (LAF) window created by
Reserve Bank of India in its credit policy of May
2011. MSF is the rate at which the banks are
able to borrow overnight funds from RBI against
the approved government securities.
 Market Stabilisation Scheme(MSS)
• Market Stabilization scheme (MSS) is a
monetary policy intervention by the RBI to
withdraw excess liquidity (or money supply) by
selling government securities in the economy. It
is used to withdraw excess liquidity or money
from the system by selling government bonds
 Qualitative measures
• Change in Marginal Requirements of Loans: Under this method money given for specific purposes is controlled. When
the central bank feels that the traders are stock-piling certain commodities and their prices are shooting up because of
this hoarding then it controls loans advanced against these commodities. This is done by changing margin-
requirements. It means that margin between the value of the security pledged and amount advanced is increased.
• Regulation of consumer's money supply as a loan: Central bank controls credit or money given to the consumers at the
time of inflation. This method was first practised in America. Large number of goods were sold to consumers on
instalment basis. It expanded money supply and prices went up. It become essential to control money supply in order to
check rising prices. Accordingly, several restrictions were imposed on instalment facilities granted to the consumers.
• Rationing of credit: Central bank of a country also functions as a lender of the last resort. If it deems necessary it can
ration credit or money supply with a view to controlling money supply. It can control money supply in four ways: 1) It
can decline to give loans to a particular bank 2) It can scale down the amount of loans to be given to different banks 3) It
can fix quota of money or credit to be given to different banks 4) It can fix the limits of loans to be given to different
industries and traders.
• Moral persuasion: Sometimes central bank by exercising moral persuasion over other banks get them agree to its
control of money supply policy.
• Publicity and propaganda: Modern age is an age of publicity. This media is made use of to implement control of money
supply or credit control policy. Central bank gives wide publicity to its money supply policy. It serves as a brief for other
banks and they act accordingly.
• Direct action: Under this policy, the central bank does not give any financial accommodation to those banks who do not
toe its line. The strict restrictions imposed by it on other banks force them to adhere to the monetary discipline.
 Fiscal Policy
Governmental activities before the Great Depression of the 1930s were minimal and, hence,
the role of fiscal policy was extremely limited. In fact, it was Keynes who popularized this
great instrument of macroeconomic policy during the 1930s’ Depression. Prior to Keynes’
appearance in economic literature, classicists believed in minimal activities of the
government in economic affairs and, hence, a small and balanced budget was considered to
be an ideal one.
But Keynes’ General Theory demolished all the classical ideas. Keynes prescribed state
intervention and balanced budget to cure economic ills from which various European
capitalist economies were suffering at that time. His policy prescription yielded dramatic
results and, since then, fiscal policy became an all-important instrument of macroeconomic
policy.
Thus, fiscal policy involves the policy relating to taxation, government spending and borrowing
programmes to affect macroeconomic variables.

“Fiscal policy is “a policy under which the government uses its expenditure and
revenue programmes to produce desirable effects and avoid undesirable effects on the
national income, production and employment.”
 Types of Fiscal Policy
Expansionary Contractionary
• A government uses this type of policy to
stimulate economic growth by increasing
• This involves cutting
spending or lowering taxes or both. The government spending or
objective of this policy is to ensure more
money in the hands of the citizens so that they raising taxes. Also, it cuts on
spend more. More spending, in turn, leads to
more income and more job creation as well.
the aggregate demand in
• There have been debates over which is more the economy. So, the
effective – tax cuts or spending. Some say that
spending in the form of public projects ensures
economic growth leading to
that the money reaches the consumers. Those the reduction in inflationary
in favor of the tax argue that tax cuts allow
businesses to hire more staff. Though there is pressures of the economy.
no consensus on which of the two is better, the
government uses a combination of both the
tools to boost economic growth.
Instruments of Fiscal Policy

Taxation policy

Deficit financing

Public expenditure

Public Debt
 Public debt(Borrowings)
• Public debt is a sound fiscal weapon to fight against inflation and deflation. It
brings about economic stability and full employment in an economy.
• (a) Borrowing from Non-Bank Public:When the government borrows from
non-bank public through sale of bonds, money may flow either out of
consumption or saving or private investment or hoarding. As a result, the effect
of debt operations on national income will vary from situation to situation. If
the bond selling schemes of the government are attractive, the people induce
to curtail their consumption, the borrowings are likely to be non inflationary.
• When the money for the purchase of bonds flows from already existing
savings, the borrowing may again be non-inflationary. Has the government not
been borrowing, these funds would have been used for private investment,
with the result that the debt operations by the government will simply bring
about a diversion of funds from one channel of spending to another with the
similar quantitative effects on national income.
Public debt(Cont.)
• (b) Borrowing from Banking System:The government may also borrow from the
banking institutions. During the period of depression, such borrowings are highly
effective. In this period, banks have excessive cash reserves and the private
business community is not willing to borrow from banks since they consider it
unprofitable.
When unused cash lying with banks is lent out to government, it causes a net
addition to the circular flow and tend to raise national income and employment.
Therefore, borrowing from banking institution have desirable and favourable
effect specially in the period of depression when the borrowed money is spend on
public works programmes.
On the contrary, borrowing from this source dry up almost completely in times of
brisk business activities i.e. boom. Actually, demand is very high during inflation
period, since profit expectation is high in business. The banks, being already
loaded up and having no excess cash reserves. Find it difficult to lend to the
government. If it is done, it is only through reducing their loans somewhere else.
This leads to a fall in private investment. As the government spending is off-set by
a reduction in private investment, there will be no net effect upon national
income and employment. In nut shell, borrowing from banking institutions have
desirable effect only in depression and is undesirable or with a neutral effect
during inflation period.
 Taxation policy
• Taxation is a powerful instrument of fiscal policy in the hands of public
authorities which greatly effect the changes in disposable income,
consumption and investment. An anti- depression tax policy increases
disposable income of the individual, promotes consumption and
investment. Obviously, there will be more funds with the people for
consumption and investment purposes at the time of tax reduction.
• This will ultimately result in the increase in spending activities i.e. it will
tend to increase effective demand and reduce the deflationary gap. In this
regard, sometimes, it is suggested to reduce the rates of commodity taxes
like excise duties, sales tax and import duty. As a result of these tax
concessions, consumption is promoted. Economists like Hansen and
Musgrave, with their eye on raising private investment, have emphasized
upon the reduction in corporate and personal income taxation to
overcome contractionary tendencies in the economy.
 Taxation policy( Cont.)
• An anti-inflationary tax policy, on the contrary, must be directed to plug the
inflationary gap. During inflation, fiscal authorities should not retain the existing tax
structure but also evolve such measures (new taxes) to wipe off the excessive
purchasing power and consumer demand. To this end, expenditure tax and excise duty
can be raised.
• The burden of taxation may be raised to the extent which may not retard new
investment. A steeply progressive personal income tax and tax on windfall gains is
highly effective to curb the abnormal inflationary pressures. Export should be
restricted and imports of essential commodities should be liberated.
• The increased inflow of supplies from origin countries will have a moderate impact
upon general prices. The tax structure should be such which may impose heavy
burden on higher income group and vice versa. Therefore, proper care must be taken
that the government policies should not bring violent fluctuations and impede
economic growth. To sum up, despite certain short-comings of taxation, its
significance as an effective anti-cyclical and growth inducing investment cannot be
forfeited.
 Public expenditure
• The active participation of the government in economic
activity has brought public spending to the front line
among the fiscal tools. The appropriate variation in public
expenditure can have more direct effect upon the level of
economic activity than even taxes. The increased public
spending will have a multiple effect upon income, output
and employment exactly in the same way as increased
investment has its effect on them. Similarly, a reduction in
public spending, can reduce the level of economic activity
through the reverse operation of the government
expenditure multiplier.
 Public expenditure(Cont.)
• During the period of inflation, the basic reason of inflationary
pressures is the excessive aggregate spending. Both private
consumption and investment spending are abnormally high. In these
circumstances, public spending policy must aim at reducing the
government spending. In other words, some schemes should be
abandoned and others be postponed. It should be carefully noted
that government spending which is of productive nature, should not
be shelved, since that may aggravate the inflationary dangers further.
• However, reduction in unproductive channels may prove helpful to
curb inflationary pressures in the economy. But such a decision is
really difficult from economic and political point of view. It is true, yet
the fiscal authority can vary its expenditure to overcome inflationary
pressures to some extent.
 Public expenditure(Cont.)
• In depression, public spending emerges with greater
significance. It is helpful to lift the economy out of
the morass of stagnation. In this period, deficiency of
demand is the result of sluggish private consumption
and investment expenditure. Therefore, it can be
met through the additional doses of public
expenditure equivalent to the deflationary gap. The
multiplier and acceleration effect of public spending
will neutralize the depressing effect of lower private
spending’s and stimulate the path of recovery.
 Deficit Financing
• Printing of money i.e. deficit financing is another method of public
expenditure for mobilizing additional resources in the hands of
government. As new money is printed, it results in a net addition to
the circular flow. Thus, this form of public borrowing is said to be
highly inflationary.
• Deficit financing has a desirable effect during depression as it helps
to raise the level of income and employment but objection is often
raised against its use at the time of inflation or boom. Here, it must
be added that through this device, the government not only gets
additional resources at minimum cost but can also create
appropriate monetary effects like low interest rates and easy money
supply and consequently economic system is likely to register a
quick revival.
 Fiscal policy and stabilizers
• AUTOMATIC STABILIZERS

• DISCRETIONARY FISCAL POLICY

• Automatic Stabilizers: fiscal policy actions that require
no action and will occur automatically based on the
current phase of the business cycle; the most common
automatic stabilizers are progressive tax systems and
transfer payments.
Examples of automatic stabilizers:
– Unemployment compensation
– A progressive income tax
• Discretionary fiscal policy:a fiscal policy action that
requires a deliberate act, such as passing a spending bill
or a tax plan