Tuesday, 17 December 2019

Fiscal Policy and Monetary Policy

       MONETARY AND FISCAL POLICY NOTES

monetary vs fiscal



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.


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