MONETARY AND FISCAL POLICY

SIOM
Fiscal Policy
Any government has to ensure a workable environment to its
citizen.
The govt. is supposed to provide a monetary environment in a
country to ensures a fair business environment for each of its
citizen to grow in long run.
Fiscal policy is the tool with which any government provides an
environment in which unemployment is least and inflation is
under control. Economic growth is maximum and is sustainable.
Fiscal policy relates to govt’s function, which ensures aggregate
demand , annual revenue collection & spending's are maximum.
Eg. Redefining tax structure; licensing, import restriction export
promotions, liquidation of gold reserves.
Monetary policy
• RBI works on behalf of govt. of India to regulate Inflation,
circulation of money and controlling interest rates for
commercial bank [ bank rate of interest][CRR]
• The purpose of monetary policy is to provide right monetary
environment for stability, and to improve the backend banking
infrastructure for better creditworthiness oriented towards the
growth and stability of the economy.
Eg. Bank rate of interest is the rate by which commercial banks are
paid interest upon its CRR . This influences lending rates to
customers.
Both fiscal and monetary policy can be either expansionary or
contractionary
 What is the Monetary Policy?
• The Monetary and Credit Policy is the policy
statement, traditionally announced twice a year,
through which the Reserve Bank of India seeks to
ensure price stability for the economy.
These factors include - money supply, interest
rates and the inflation. In banking and economic
terms money supply is referred to as M3 - which
indicates the level (stock) of legal currency in the
economy.
Besides, the RBI also announces norms for the
banking and financial sector and the institutions
which are governed by it.
 How is the Monetary Policy different
from the Fiscal Policy?
• Fiscal policy is formulated by govt. monetary policy by RBI
• The Monetary Policy regulates the supply of money and regulates
cost and availability of credit in the economy. It deals with both the
lending and borrowing rates of interest for commercial banks.
• The Monetary Policy aims to maintain price stability, full
employment and economic growth.
• The Monetary Policy is different from Fiscal Policy as it regulates
particular sector changing monetary environment & interest rate in
that sector, whereas fiscal policy is a broader tool with the
government.
• The Fiscal Policy can be used to overcome recession and control
inflation. It may be defined as a deliberate change in government
revenue and expenditure to influence the level of national output
and prices.
 What are the objectives of the
Monetary Policy?
• The objectives are to maintain price stability and
ensure adequate flow of credit to the productive
sectors of the economy.
To increase stability for the national currency in
international market, growth in employment and
income in internal market. The monetary policy
affects the particular sector through long and
variable periods while the financial markets are
also impacted through short-term implications.
INSTRUMENTS OF MONETARY POLICY
• 1. Bank Rate of Interest
• 2. Cash Reserve Ratio
• 3. Statutory Liquidity Ratio
• 4. Open market Operations
• 5. Margin Requirements
• 6. Deficit Financing
• 7. Issue of New Currency
• 8. Credit Control
 Bank Rate of Interest

It is the interest rate which is fixed by the RBI to control the

lending capacity of Commercial banks . During Inflation , RBI
increases the bank rate of interest due to which borrowing
power of commercial banks reduces which thereby reduces the
supply of money or credit in the economy .When Money
supply Reduces it reduces the purchasing power and thereby
curtailing Consumption and lowering Prices.
 Cash Reserve Ratio
CRR, or cash reserve ratio, refers to a portion of deposits (as
cash) which banks have to keep/maintain with the RBI. During
Inflation RBI increases the CRR due to which commercial
banks have to keep a greater portion of their deposits with
the RBI . This serves two purposes. It ensures that a portion of
bank deposits is totally risk-free and secondly it enables that
RBI control liquidity in the system, and thereby, inflation.
 Statutory Liquidity Ratio

Banks are required to invest a portion of their

deposits in government securities as a part of
their statutory liquidity ratio (SLR)
requirements . If SLR increases the lending
capacity of commercial banks decreases
thereby regulating the supply of money in the
economy.
 Open market Operations
It refers to the buying and selling of Govt.
securities in the open market . During inflation
RBI sells securities in the open market which
leads to transfer of money to RBI.Thus money
supply is controlled in the economy.
 Margin Requirements
• During Inflation RBI fixes a high rate of margin
on the securities kept by the public for
loans .If the margin increases the commercial
banks will give less amount of credit on the
securities kept by the public thereby
controlling inflation.
 Deficit Financing
• It means printing of new currency notes by
Reserve Bank of India .If more new notes are
printed it will increase the supply of money
thereby increasing demand and prices.
• Thus during Inflation, RBI will stop printing
new currency notes thereby controlling
inflation.
 Issue of New Currency
• During Inflation the RBI will issue new
currency notes replacing many old notes.
This will reduce the supply of money in the
economy.
 Fiscal Policy
• It refers to the Revenue and Expenditure
policy of the Govt. which is generally used to
cure recession and maintain economic
stability in the country.
 Instruments of Fiscal Policy
• 1. Reduction of Govt. Expenditure
• 2. Increase in Taxation
• 3. Imposition of new Taxes
• 4. Wage Control
• 5.Rationing
• 6. Public Debt
• 7. Increase in savings
• 8. Maintaining Surplus Budget
 Other Measures

• 1. Increase in Imports of Raw materials

• 2. Decrease in Exports
• 3. Increase in Productivity
• 4. Provision of Subsidies
• 5. Use of Latest Technology
• 6. Rational Industrial Policy
 Inflation
Inflation is a rise in the general level of
prices of goods and services in an
economy over a period of time. When
the price level rises, each unit of
currency buys fewer goods and services.
A chief measure of price inflation is the
inflation rate. When Prices rise the
Value of Money falls.
 STAGES OF INFLATION
• 1. CREEPING INFLATION (0%-3%)

• 2. WALKING INFLATION ( 3% - 7%)

• 3. RUNNING INFLATION (10% - 20 %)

• 4. HYPER INFLATION ( 20% and abv)

 TYPES OF INFLATION
1. Demand Pull Inflation- when derived demand of the
community is more than the products available.
2. Cost Push Inflation- when the supply of products are less
then the sellers push the cost up and cost push situation
arises.
As per J M Keynes the situation of inflation is good for the
economy. As it connotes better liquidity, boom and
despite high interests production plans are optimistic.
Growth rates are high exports are better. Current Account
Deficit CAD situation improves.
 Causes of Inflation
• 1. Demand pull Inflation
Causes for Increase in Demand :-
a) Increase in Money Supply
b) Increase in Black Marketing
c) Increase in Hoarding
d) Repayment of Past Internal Debt
e) Increase in Exports
f) Deficit Financing
 Cont……….
g)Increase in Income
h)Demonstration Effect
i)Increase in Black money
j) Credit facilities by bank improves
 Cont….
• 2) Cost Push Inflation
Causes for Increase in Cost :-
a) Increase in cost of raw materials
b)Shortage of Supplies
c) Natural calamities
d)Industrial Disputes
e) Increase in Exports
f) Increase in Wages
g) Increase in Transportation Cost
h)Huge Expenditure on Advertisement
 Effects of Inflation
• Inflation can have positive and negative effects
on an economy. Negative effects of inflation
include loss in stability in the real value of money
and other monetary items over time; uncertainty
about future inflation may discourage investment
and saving, and high inflation may lead to
shortages of goods if consumers begin hoarding
out of concern that prices will increase in the
future. Positive effects include a mitigation of
economic recessions, and debt relief by reducing
the real level of debt.
Effects of Inflation Cont…..
1. Effect on Producers
2. Effect on Debtors
3. Effect on Creditors
4. Effect on Fixed Income Group
5. Effect on Wage Earners
6. Effect on Equity Holders
7. Effect on farmers
8. Effect on Production
Effects of Inflation…
9.Effect on Hoarding
10.Effect on value of Money
11.Effect on Investment
12. Effect on savings