monetary & fiscal policy

MONETARY POLICY &

FISCAL POLICY

DR. VANDANA BHAVSAR [PhD]

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Fiscal PolicyRelated to

budget, Govt. Exp., Taxation,

Public Debt

Monetary Policy

Related to Ms, Exchange rate control, Bank rate control,Interest Rate

MACROECONOMIC POLICIES

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MONETARY POLICYRegulation of supply of Money & Cost, Availability of Credit in the economy

Variables affected by Monetary Policy in the economy

Interest RatesLiquidityCredit AvailabilityExchange Rates

Purpose of Monetary Policy

Macroeconomic stability - Maintain price stability, ensure adequate flow of credit to the productive sectors of the economy & overall economic growth

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OBJECTIVES OF M. P.Monetary policy is an instrument which affect the credit flow in an economy.

The variation affect the demand & supply of credit in an economy & the level or nature of economic activities■Stability in price level■Economic development■Arrangement of full employment■Expansion of credit facility■Stability in exchange rate

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MONETARYPOLICY

QUALITATIVECONTROL

QUANTITATIVECONTROL

INSTRUMENTS OF M. P.GENERAL (QUANTITATIVE) MethodsSELECTIVE (QUALITATIVE) Methods

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GENERAL (QUANTITATIVE) METHODS

Helps in credit control in the economy.

Affect total quantity of the credit.Methods of general monetary policy

■ Bank Rate Policy■ Open Market Policy■ Cash Reserve Ratio■ Statuary Liquidity Reserve Ratio■ Repo Rate■ Reverse Repo Rate05:44:19 AM 6

Target Variables -Inflation-Interest rate-Real GDP-Employment-Consumption-Savings-Investment

Policy Variables- Money supply- OMO: Liquidity conditions- policy rates (CRR, repo etc.)

MONETARY POLICY – INFLUENCE

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BANK RATE POLICYTraditional approach:- Bank rate

means on which central bank discounts and rediscount the eligible bills.

Today’s approach:- Bank rate means the minimum rate on which central bank provides financial accommodation to commercial bank in the discharge of its function as the lender of the last resort.

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EFFECTS OF BANK RATE in bank rate

Commer-cial banks interest rate

Demand for credit & loans

Flow of money

in bank rate

Commercial banks interest

rate

Demand for credit & loans

Flow of money

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OPEN MARKET OPERATIONIt includes the sales and purchase by the central bank of ….AssetsForeign exchangeGoldGovernment securitiesCompany securities

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USE OF O. M. O.

In The Inflationary Situation

RBI sales out the securities to commerc-

ial bank

RBI decreases the money

supply

In The Recessionary

Situation

RBI purchases securities

from commercial

bank.

RBI increases the money

supply.

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CASH RESERVE RATIO

Commercial bank by law has to keep a certain percentage of its deposits with central bank.

It controls the cash flow in economy.

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STATUARY LIQUIDITY RATIO

Commercial bank is to keep a certain percentage of its deposit as liquid asset.

It controls the cash flow in economy.

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USE OF C.R.R. & S.L.RIn Inflationary Situation

Increase the percentage of CRR & SLR

Reduces the Ms in an economy

In Recessionary Situation

Decrease the percentage of CRR & SLR

Increases the Ms in an economy05:44:19 AM 14

MEANING OF REPO RATERepurchase Agreement or Ready Forward

[REPO]. A Repo involves a simultaneous "sale and

repurchase" agreement. It enables collateralized short term borrowing

and lending through sale/purchase operations in debt instruments

Repo rate is the interest rate charged by the Central bank when banks borrow money from it against pledging its securities

RBI increases the repo rate loans to banks costlier

Similarly, RBI decreases repo rate loans to banks cheaper. 05:44:20 AM 15

REVERSE REPOThe rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate.

If the reverse repo rate is increased RBI will borrow money from the bank offer them a lucrative rate of interest banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk)

Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economy

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IMPORTANCE OF REPO & REVERSE REPO

Reverse repo rate -- the rate at which the central bank absorbs liquidity from the banksRepo -- the rate at which liquidity is injectedIt helps borrower to raise funds at better rates

An SLR surplus and CRR deficit bank can use the Repo deals as a convenient way of adjusting SLR/CRR positions simultaneously.

RBI uses Repo and Reverse repo as instruments for liquidity adjustment in the system

Reverse Repo is undertaken to earn additional income on idle cash. 05:44:20 AM 17

SUMMARY OF QUANTITATIVE METHODSEXPANSION OF CREDIT

Reduce Bank RatePurchase of securities

Reduce C.R.R.

Reduce S.L.R

Reduce Repo RateReduce Reverse

Repo Rate

CONTRACTION OF CREDIT

Increase Bank Rate

Sales Of Securities

Increase C.R.R.

Increase S.L.R.Increase Repo

RateIncrease Reverse

Repo Rate05:44:20 AM 18

SPECIFIC/QUALITATIVE CREDIT CONTROL

Adopt for expansion and contraction of credit to attain specific objective.

Methods of qualitative credit control■Credit rationing

■Change in margin

■Direct action05:44:20 AM 19

LIMITATIONS OF M. P. Conflicting Goals

Limitations During Deflation

Limitations During Inflation

Near Money Assets

NBFIS

Attitude Of Banks

Limitation In Underdeveloped Countries

Inside & Outside Lag05:44:20 AM 20

FISCAL POLICY

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HISTORYImportance of Fiscal Policy – Post Great

Depression

The ineffectiveness of monetary policy as a means of overcoming the severe unemployment of the Great Depression

The development of the new economics by Keynes with its emphasis on aggregate demand.

Fiscal policy is based on the theories of British economist John Maynard Keynes [also known as Keynesian Economics]

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MEANINGMeasures related to taxation & public expenditure are normally called fiscal measures and the policy concerning them is known as FISCAL POLICY.

In short, fiscal policy or budgetary policy consists of steps & measures which the government implements to fulfill the aims of economic policy.

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TARGET VARIABLES► Aggregate Demand► Inflation► Employment► Consumption► Savings► Investment

[resource allocation]► Income Distribution

INSTRUMENTS ► Public Revenue ► Public Spending► Public Debt

FISCAL POLICY – INFLUENCE

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OBJECTIVES OF F. P.To achieve and maintain the full employment in the economy.

Attain Economic growth in long term.

Achieve economic stability.

To guide the allocation of existing resources into socially necessary lines of development.

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INSTRUMENTS OF F. P. PUBLIC EXPENDITURE

■Plan & Non - Plan■ Development & Non- Development

PUBLIC REVENUE■ Tax■ Non - Tax

PUBLIC DEBT■ Internal Debt■ External Debt

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PUBLIC EXPENDITURERevenue Expenditure Capital

ExpenditurePlan Expenditure■Central Plan such as agriculture, rural development, social service and others

■Central Assistance for plans to States and UTs

Plan ExpenditureDevelopmental Projects

Non – Plan Expenditure■Interest Payments■Subsidies■Debt relief to farmers■Grant to states and UTs■Others

Non – Plan Expenditure■Loans to PSUs■Loans to states and UTs■Defense

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EFFECTS OF P. E.•Govt. exp. should be reduced in inflation and increased during depressions in case of a deflationary situation in an economy. Therefore it act as a balancing factor between saving & investment

Pump Priming - The government spending which will have the effect of setting the economy going on the way towards full utilization of resources. E.g. Govt. Exp., building infrastructure etc.

Compensatory Spending - The government spending which will have the effect of setting the social objective and payment of interest on debt. E.g. schools, hospitals, pensions, relief payments etc.05:44:20 AM 28

Public RevenueRevenue Receipts Capital Receipts

Tax Revenue: Direct Taxes

■Income Tax■Corporate Tax■Wealth Tax Indirect Taxes■ Customs ■ Excise■ Others

Market Borrowing-internal debtDisinvestment of PSUsRecoveries of loansBorrowing from external markets External loans/Debts from

world institutions

■Non Tax Revenue■Interest receipts■Dividend■Profits of PSUs■Revenue from social services

like education and hospitals■External Grants

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TAXATIONMeaning:-

■Source of Revenue■Helps Govt. to do there exp.■Generated from public

Direct Tax - Direct tax are those tax which a person pay to government directly for himself and can not enforce on others, for e.g. income tax, wealth tax etc.

Indirect Tax - Indirect tax are those tax which a person can on others, for e.g. service tax, sales tax etc.

■

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Public DebtWhen Govt. exp. are more then Govt. revenue Government take Public Debt.

Deficit financing = Govt. exp. – Govt. revenue.

Government take the public debt to fulfill the gap between its exp. and the revenue.

Government debt can be categorized as internal debt-owed to lenders within the country, and external debt-owed to foreign lenders.

Government Borrowing leads to Crowding out effect 05:44:20 AM 31

CROWDING OUT EFFECTIn economics, when the government expands its borrowing to finance increased expenditure, crowding out occurs of private sector investment by way of higher interest rates

If increased borrowing leads to higher interest rates by creating a greater demand for money and loanable funds and hence a higher "price" (ceteris paribus), the private sector, which is sensitive to interest rates will likely reduce investment due to a lower rate of return. This is the investment that is crowded out.

More importantly, a fall in fixed investment by business can hurt long-term economic growth of the supply side, i.e., the growth of potential output.

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INDICATORS OF FISCAL IMBALANCESRevenue Deficit

■Revenue expenditure is met out of current revenue receipts

Revenue Deficit = R. Exp. – R. ReceiptsFiscal Deficit

■It is the difference between the government's total receipts (excluding borrowing) and total expenditure.

■Fiscal deficit gives the signal to the government about the total borrowing requirements from all sources.

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WAYS AND MEANS ADVANCES - NEW SCHEME

[WMA]Under the new scheme RBI provides facilities for temporary accommodation up to a ceiling fixed in advance

The limit for WMA and rate of interest on WMA will be mutually agreed to between the Reserve Bank and govt. from time to time

The credit thus drawn has to be repaid or in technical language Govt. vacates WMA from time to time.

As a result WMA will be reduced to zero at the end of financial year

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LIMITATIONS OF F. P.Limitations during deflationLimitations during inflationLimitations in underdeveloped countriesLack of adequate forecastingSize of fiscal measuresChanges in the B.O.PsNature of people’s effortsBurden of public debtProblems relating to deficit Financing

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Global GDP -0.6%

Estimated PPP Global Growth

0.5%

Recession

USEurope

Japan

Demand Slump

Production Plunge

Job losses

Tighter credit

World trade contraction

by 2.8%

Aggressive and unconventional measures taken by Governments and central banks

CURRENT GLOBAL SCENARIO

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Money and credit market

Local Institutions

Domestic Banks

Domestic MFs NBFC

$ReRe.

Financial Channel

IMPACT ON INDIA

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Monetary Policy

Fiscal Policy Growth AmidGlobal Economic Slowdown

DeflationRs.

CHALLENGES FOR RBI

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•7.25 (June ‘12)Inflation•9.0% http://www.rbi.org.in/home.aspxBank Rate•4.75%CRR•24.0%SLR•8.0%Repo Rate•7.0%Reverse Repo Rate

•10.0% – 10.50%Base Rate•55.76Re/$

CURRENT RATES

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Some facts and figuresMonetary policy is been framed

by……………Fiscal policy is been framed by………………Present governor of R.B.I……………………Present Finance minister of

India……………….Current S.L.R…………………….Current C.R.R…………………..

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THANK YOU

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