MONETARY POLICY &
FISCAL POLICY
DR. VANDANA BHAVSAR [PhD]
05:44:18 AM 1
Fiscal PolicyRelated to
budget, Govt. Exp., Taxation,
Public Debt
Monetary Policy
Related to Ms, Exchange rate control, Bank rate control,Interest Rate
MACROECONOMIC POLICIES
05:44:18 AM 2
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
05:44:18 AM 3
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
05:44:19 AM 4
MONETARYPOLICY
QUALITATIVECONTROL
QUANTITATIVECONTROL
INSTRUMENTS OF M. P.GENERAL (QUANTITATIVE) MethodsSELECTIVE (QUALITATIVE) Methods
05:44:19 AM 5
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
05:44:19 AM 7
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.
05:44:19 AM 8
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
05:44:19 AM 9
OPEN MARKET OPERATIONIt includes the sales and purchase by the central bank of ….AssetsForeign exchangeGoldGovernment securitiesCompany securities
05:44:19 AM 10
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.
05:44:19 AM 11
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.
05:44:19 AM 12
STATUARY LIQUIDITY RATIO
Commercial bank is to keep a certain percentage of its deposit as liquid asset.
It controls the cash flow in economy.
05:44:19 AM 13
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
05:44:20 AM 16
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
05:44:20 AM 21
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]
05:44:20 AM 22
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.
05:44:20 AM 23
TARGET VARIABLES► Aggregate Demand► Inflation► Employment► Consumption► Savings► Investment
[resource allocation]► Income Distribution
INSTRUMENTS ► Public Revenue ► Public Spending► Public Debt
FISCAL POLICY – INFLUENCE
05:44:20 AM 24
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.
05:44:20 AM 25
INSTRUMENTS OF F. P. PUBLIC EXPENDITURE
■Plan & Non - Plan■ Development & Non- Development
PUBLIC REVENUE■ Tax■ Non - Tax
PUBLIC DEBT■ Internal Debt■ External Debt
05:44:20 AM 26
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
05:44:20 AM 27
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
05:44:20 AM 29
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.
■
05:44:20 AM 30
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.
05:44:20 AM 32
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.
05:44:20 AM 33
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
05:44:20 AM 34
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
05:44:20 AM 35
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
05:44:21 AM 36
Money and credit market
Local Institutions
Domestic Banks
Domestic MFs NBFC
$ReRe.
Financial Channel
IMPACT ON INDIA
05:44:21 AM 37
Monetary Policy
Fiscal Policy Growth AmidGlobal Economic Slowdown
DeflationRs.
CHALLENGES FOR RBI
05:44:21 AM 38
•7.25 (June ‘12)Inflation•9.0% http://www.rbi.org.in/home.aspxBank Rate•4.75%CRR•24.0%SLR•8.0%Repo Rate•7.0%Reverse Repo Rate
•10.0% – 10.50%Base Rate•55.76Re/$
CURRENT RATES
05:44:21 AM 39
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…………………..
05:44:21 AM 40
THANK YOU
05:44:21 AM 41