MONETARY AND MONETARY AND FISCAL POLICIESFISCAL POLICIES

InflationInflation

InflationInflation is a rise in the general is a rise in the general level of prices of goods and services level of prices of goods and services in an economy over a period of time. in an economy over a period of time. When the price level rises, each unit When the price level rises, each unit of currency buys fewer goods and of currency buys fewer goods and services. A chief measure of price services. A chief measure of price inflation is the inflation rate.When inflation is the inflation rate.When Prices rise the Value of Money falls. Prices rise the Value of Money falls.

STAGES OF INFLATIONSTAGES OF INFLATION

1. CREEPING INFLATION (0%-3%)1. CREEPING INFLATION (0%-3%)

2. WALKING INFLATION ( 3% - 7%)2. WALKING INFLATION ( 3% - 7%)

3. RUNNING INFLATION3. RUNNING INFLATION (10% - 20 (10% - 20 %)%)

4. HYPER INFLATION4. HYPER INFLATION ( 20% and abv) ( 20% and abv)

TYPES OF INFLATIONTYPES OF INFLATION

1. Demand Pull Inflation1. Demand Pull Inflation

2. Cost Push Inflation2. Cost Push Inflation

Causes of InflationCauses of Inflation

1. Demand pull Inflation1. Demand pull Inflation

Causes for Increase in Demand :-Causes for Increase in Demand :-a)a) Increase in Money SupplyIncrease in Money Supply

b)b) Increase in Black MarketingIncrease in Black Marketing

c)c) Increase in HoardingIncrease in Hoarding

d)d)Repayment of Past Internal DebtRepayment of Past Internal Debt

e)e) Increase in ExportsIncrease in Exports

f)f) Deficit FinancingDeficit Financing

Cont……….Cont……….

g) Increase in Incomeg) Increase in Income

h) Demonstration Effecth) Demonstration Effect

i) Increase in Black moneyi) Increase in Black money

j) Increase in Credit facilitiesj) Increase in Credit facilities

Cont….Cont…. 2) Cost Push Inflation2) Cost Push InflationCauses for Increase in Cost :-Causes for Increase in Cost :-a)a)Increase in cost of raw materialsIncrease in cost of raw materialsb)b)Shortage of SuppliesShortage of Suppliesc)c)Natural calamitiesNatural calamitiesd)d)Industrial DisputesIndustrial Disputese)e)Increase in ExportsIncrease in Exportsf)f) Increase in WagesIncrease in Wagesg)g)Increase in Transportation CostIncrease in Transportation Costh)h)Huge Expenditure on AdvertisementHuge Expenditure on Advertisement

Effects of InflationEffects of Inflation

Inflation can have positive and negative Inflation can have positive and negative effects on an economy. Negative effects of effects on an economy. Negative effects of inflation include loss in stability in the real inflation include loss in stability in the real value of money and other monetary items value of money and other monetary items over time; uncertainty about future inflation over time; uncertainty about future inflation may discourage investment and saving, and may discourage investment and saving, and high inflation may lead to shortages of goods high inflation may lead to shortages of goods if consumers begin hoarding out of concern if consumers begin hoarding out of concern that prices will increase in the future. Positive that prices will increase in the future. Positive effects include a mitigation of economic effects include a mitigation of economic recessions, and debt relief by reducing the recessions, and debt relief by reducing the real level of debt.real level of debt.

Cont…..Cont…..

1.1. Effect on ProducersEffect on Producers2.2. Effect on DebtorsEffect on Debtors3.3. Effect on CreditorsEffect on Creditors4.4. Effect on Fixed Income GroupEffect on Fixed Income Group5.5. Effect on Wage EarnersEffect on Wage Earners6.6. Effect on Equity HoldersEffect on Equity Holders7.7. Effect on farmersEffect on farmers8.8. Effect on ProdutionEffect on Prodution

9.Effect on Hoarding9.Effect on Hoarding

10.Effect on value of Money10.Effect on value of Money

11.Effect on Investment11.Effect on Investment

12. Effect on savings12. Effect on savings

What is the Monetary Policy?What is the Monetary Policy? The Monetary and Credit Policy is the policy The Monetary and Credit Policy is the policy

statement, traditionally announced twice a statement, traditionally announced twice a year, through which the Reserve Bank of India year, through which the Reserve Bank of India seeks to ensure price stability for the seeks to ensure price stability for the economy. economy.

These factors include - money supply, interest These factors include - money supply, interest rates and the inflation. In banking and rates and the inflation. In banking and economic terms money supply is referred to economic terms money supply is referred to as M3 - which indicates the level (stock) of as M3 - which indicates the level (stock) of legal currency in the economy. legal currency in the economy.

Besides, the RBI also announces norms for Besides, the RBI also announces norms for the banking and financial sector and the the banking and financial sector and the institutions which are governed by it. institutions which are governed by it.

How is the Monetary Policy How is the Monetary Policy different from the Fiscal Policy? different from the Fiscal Policy?

The Monetary Policy regulates the supply of money and the The Monetary Policy regulates the supply of money and the cost and availability of credit in the economy. It deals with both cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial the lending and borrowing rates of interest for commercial banks. banks.

The Monetary Policy aims to maintain price stability, full The Monetary Policy aims to maintain price stability, full employment and economic growth. employment and economic growth.

The Monetary Policy is different from Fiscal Policy as the The Monetary Policy is different from Fiscal Policy as the former brings about a change in the economy by changing former brings about a change in the economy by changing money supply and interest rate, whereas fiscal policy is a money supply and interest rate, whereas fiscal policy is a broader tool with the government. broader tool with the government.

The Fiscal Policy can be used to overcome recession and The Fiscal Policy can be used to overcome recession and control inflation. It may be defined as a deliberate change in control inflation. It may be defined as a deliberate change in government revenue and expenditure to influence the level of government revenue and expenditure to influence the level of national output and prices. national output and prices.

What are the objectives of the What are the objectives of the Monetary Policy?Monetary Policy?

The objectives are to maintain price stability The objectives are to maintain price stability and ensure adequate flow of credit to the and ensure adequate flow of credit to the productive sectors of the economy. productive sectors of the economy.

Stability for the national currency (after Stability for the national currency (after looking at prevailing economic conditions), looking at prevailing economic conditions), growth in employment and income are also growth in employment and income are also looked into. The monetary policy affects the looked into. The monetary policy affects the real sector through long and variable real sector through long and variable periods while the financial markets are also periods while the financial markets are also impacted through short-term implications. impacted through short-term implications.

INSTRUMENTS OF INSTRUMENTS OF MONETARY POLICYMONETARY POLICY

1. Bank Rate of Interest1. Bank Rate of Interest 2. Cash Reserve Ratio2. Cash Reserve Ratio 3. Statutory Liquidity Ratio3. Statutory Liquidity Ratio 4. Open market Operations4. Open market Operations 5. Margin Requirements5. Margin Requirements 6. Deficit Financing6. Deficit Financing 7. Issue of New Currency7. Issue of New Currency 8. Credit Control8. Credit Control

Bank Rate of InterestBank Rate of Interest

It is the interest rate which is fixed by the RBI to control the It is the interest rate which is fixed by the RBI to control the lending capacity of Commercial banks . During Inflation , lending capacity of Commercial banks . During Inflation , RBI increases the bank rate of interest due to which RBI increases the bank rate of interest due to which borrowing power of commercial banks reduces which borrowing power of commercial banks reduces which thereby reduces the supply of money or credit in the thereby reduces the supply of money or credit in the economy .When Money supply Reduces it reduces the economy .When Money supply Reduces it reduces the purchasing power and thereby curtailing Consumption and purchasing power and thereby curtailing Consumption and lowering Prices.lowering Prices.

Cash Reserve RatioCash Reserve Ratio

CRR, or cash reserve ratio, refers to a portion of CRR, or cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain deposits (as cash) which banks have to keep/maintain with the RBI. During Inflation RBI increases the CRR with the RBI. During Inflation RBI increases the CRR due to which commercial banks have to keep a greater due to which commercial banks have to keep a greater portion of their deposits with the RBI . This serves two portion of their deposits with the RBI . This serves two purposes. It ensures that a portion of bank deposits is purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation. liquidity in the system, and thereby, inflation.

Statutory Liquidity RatioStatutory Liquidity Ratio

Banks are required to invest a portion of Banks are required to invest a portion of their deposits in government securities as their deposits in government securities as a part of their statutory liquidity ratio a part of their statutory liquidity ratio (SLR) requirements . If SLR increases (SLR) requirements . If SLR increases the lending capacity of commercial banks the lending capacity of commercial banks decreases thereby regulating the supply decreases thereby regulating the supply of money in the economy.of money in the economy.

Open market OperationsOpen market Operations

It refers to the buying and selling of It refers to the buying and selling of Govt. securities in the open market . Govt. securities in the open market . During inflation RBI sells securities in the During inflation RBI sells securities in the open market which leads to transfer of open market which leads to transfer of money to RBI.Thus money supply is money to RBI.Thus money supply is controlled in the economy.controlled in the economy.

Margin RequirementsMargin Requirements

During Inflation RBI fixes a high rate of During Inflation RBI fixes a high rate of margin on the securities kept by the margin on the securities kept by the public for loans .If the margin increases public for loans .If the margin increases the commercial banks will give less the commercial banks will give less amount of credit on the securities kept by amount of credit on the securities kept by the public thereby controlling inflation.the public thereby controlling inflation.

Deficit FinancingDeficit Financing

It means printing of new currency notes It means printing of new currency notes by Reserve Bank of India .If more new by Reserve Bank of India .If more new notes are printed it will increase the notes are printed it will increase the supply of money thereby increasing supply of money thereby increasing demand and prices.demand and prices.

Thus during Inflation, RBI will stop Thus during Inflation, RBI will stop printing new currency notes thereby printing new currency notes thereby controlling inflation.controlling inflation.

Issue of New CurrencyIssue of New Currency

During Inflation the RBI will issue new During Inflation the RBI will issue new currency notes replacing many old currency notes replacing many old notes.notes.

This will reduce the supply of money in This will reduce the supply of money in the economy.the economy.

Fiscal PolicyFiscal Policy

It refers to the Revenue and Expenditure It refers to the Revenue and Expenditure policy of the Govt. which is generally policy of the Govt. which is generally used to cure recession and maintain used to cure recession and maintain economic stability in the country.economic stability in the country.

Instruments of Fiscal Instruments of Fiscal PolicyPolicy

1. Reduction of Govt. Expenditure1. Reduction of Govt. Expenditure 2. Increase in Taxation2. Increase in Taxation 3. Imposition of new Taxes3. Imposition of new Taxes 4. Wage Control4. Wage Control 5.Rationing5.Rationing 6. Public Debt6. Public Debt 7. Increase in savings7. Increase in savings 8. Maintaining Surplus Budget8. Maintaining Surplus Budget

Other MeasuresOther Measures

1. Increase in Imports of Raw materials1. Increase in Imports of Raw materials 2. Decrease in Exports2. Decrease in Exports 3. Increase in Productivity3. Increase in Productivity 4. Provision of Subsidies4. Provision of Subsidies 5. Use of Latest Technology5. Use of Latest Technology 6. Rational Industrial Policy6. Rational Industrial Policy