MONETARY AND FISCAL POLICY NOTES
Monetary And Fiscal Policy Notes
Monetary policy:-
Monetary policy is a central
bank's actions and communications that manage
the money supply. That includes credit, cash, checks, and money
market mutual funds.
The objective of the monetary policy
There are three main objectives of the monetary
policy
- The
most important is to control the inflation rate.
- The secondary
objective is to reduce unemployment
- The third objective is to promote the long term interest rate
Tools of monetary policy
1. Open market operation:-
Open
Market Operations is when the RBI involves itself directly and buys or sells
short-term securities in the open market. This is a direct and effective way to
increase or decrease the supply of money in the market. It also has a direct
effect on the ongoing rate of interest in the market.
2. Bank rate:-
One of the most
effective instruments of monetary policy is the bank rate. A bank rate is
essentially the rate at which the RBI lends money to commercial banks without
any security or collateral. It is also the standard rate at which the RBI will
buy or discount other such commercial instruments.
3. Cash reserve ratio(CRR):-
Is the portion of deposits with the commercial banks that it has to deposit to the
RBI. So CRR is the percent of deposits the commercial banks have to keep with
the RBI. The RBI will adjust the said percentage to control the supply of money
available with the bank.
4. Statutory Liquidity Ratio (SLR):-
Is the
percent of total deposits that have to keep with themselves in the form of cash
reserves or gold. So increasing the SLR will mean the banks have fewer funds to
give as loans thus controlling the supply of money in the economy.
5. Liquidity Adjustment Facility:-
It is an indirect instrument for monetary control. It controls the
flow of money through repo rates and reverse repo rates.
Repo rate:-
The repo rate is actually, the rate at which commercial banks and other
institutes obtain short-term loans from the Central Bank.
Reverse
repo rate:-
the
reverse repo rate is the rate at which the RBI parks its funds with the
commercial banks for a
short time periods.
6. Moral suasion:-
This is an informal method of monetary control. If there is a
need it can urge the banks to exercise credit control at times to maintain the
balance of funds in the market. This method is actually quite effective since
banks tend to follow the policies set by the RBI.
Fiscal policy
By
which the government adjusts its spending levels along with tax rates to
influence and monitor the nation’s economy it is known as fiscal policy. These include subsidy, taxation, welfare expenditure, etc.
Also, there are certain investment and disinvestment policies and debt and
surplus management that contribute to fiscal
policies.
The objective of the fiscal policy
1. To stabilize the pricing level in the economy.
2.
To achieve and maintain the level of full
employment in the country.
3.
Also, to stabilize the growth rate in the
economy.
4.
To promote economic development in a
country.
5. In order to maintain the level of balance of payment in
the economy.
Type of fiscal policy
There
are two types of fiscal policy expansionary policy and contractionary policy.
Expansionary fiscal policy
Expansionary fiscal policy is a form of fiscal
policy that involves decreasing taxes, increasing government expenditures
or both, in order to fight recessionary pressures.
Expansionary
fiscal policy is usually financed by increased government borrowing – and
selling bonds to the private sector.
Keynes
said expansionary fiscal policy should be used during a recession – when there
is unemployment, surplus saving and falling real output. He argued this
injection of government spending could stimulate economic activity and get the
unemployed resources back into productive use. This enables the economy to
recover more quickly than a laissez-faire approach.
Contractionary policy
is a
monetary measure referring either to a reduction in government
spending—particularly deficit spending—or a reduction in the rate of monetary
expansion by a central bank. It is a type of macroeconomic tool designed to
combat rising inflation or other economic distortions created by central banks
or government interventions. Contractionary policy is the polar opposite of expansionary policy.
Also Read:Error of Principle :
Meaning
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