Monetary & Fiscal Policy

Module - 5

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 Monetary Policy
Extent of Money:
The central bank measures the
 Monetary policy is a extent of money & credit
policy statement available in the economy
through which the using the indices like
M0,M1,M2,M3.
central bank
( RBI ) targets key The sources of M3 are :
set of indicators to Bank credits, Govt.’s
currency liability to public ,
ensure price net foreign exchange
stability in the reserves of banks.
economy. Expansion of Money
 These indicators Supply:
include Money supply in the economy
will be increased by RBI
• Money supply through issue of currency,
( M3) budgetary operations and
borrowings by govt. from
• Interest rate foreign countries.
• Inflation
Growth in money supply should
 This policy is
12/14/2008 Surana College be more than the growth in 2
PG Centre
 Monetary Policy
Contraction of Money:
Unlimited supply of money results in
hyper-inflation, which hits all
sections of economy. Hence RBI
use ‘Credit Control Measures’ to
reduce the money supply.
Credit Control Measures are:
1. General controls
2. Selective controls
General controls are:
• Bank Rate,
• Cash Reserve Requirement ,
• Statutory Liquidity Ratio , and
• Refinance policy.
• Open market Operations
• Special facility to some
groups
• Liberalisation of Bill Market
Scheme
Selective Controls are:
• Insisting minimum margin for
lending against certain
securities
• 12/14/2008
Fixing ceiling on certain Surana College PG
credits
Bank Rate:
The rate at which RBI lends
money to other banks .
 During Inflation time RBI will
increase the bank rate . This
will affect the borrowers.
During the period of falling
prices this rate will be
reduced.
Cash Reserve
Requirement ( CRR ):
All commercial banks have
to keep certain
percentage of demand &
time deposits with RBI.
This is called CRR.
 During Inflation time RBI
will increase the CRR .
This will reduce the fund
available for issuing
credit.
Centre
During the period
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 Monetary Policy
Statutory Liquidity Ratio
( SLR ):
All commercial banks in addition to
CRR have to keep certain
percentage of demand & Time
deposits with RBI in the form of
liquid assets like Cash , Gold or
approved securities.
 It will be increased to reduce
the money supply & vice
versa
 Present rate is 30%
Refinance Policy:
Based on the liquidity position
of commercial banks RBI
provides fund . This is used
by RBI to control the credit
issued by banks.
Open market operations:
Based on the money supply in
the economy RBI will buy
gold and securities from
public to expand money
12/14/2008 Surana College PG Centre
Bank Rate:
The rate at which RBI lends money
to other banks .
 During Inflation time RBI will
increase the bank rate . This will
affect the borrowers. During
the period of falling prices this
rate will be reduced.
Cash Reserve Requirement
( CRR ):
All commercial banks have to
keep certain percentage of
demand & time deposits
with RBI. This is called CRR.
 During Inflation time RBI will
increase the CRR . This will
reduce the fund available for
issuing credit. During the
period of falling prices this
rate will be reduced.
 Present rate is 9%
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 Monetary Policy
Special facilities to some Objectives of Monetary
groups: Policy:
RBI advise banks to liberally 2. To reduce inflation by
issue credit facility to Small contracting money supply
scale industries, self 3. To print new currency
employed etc. . This will with a view to reduce the
increase money supply and trade deficit
vice versa to reduce the
money supply 4. Boosting export to reduce
Commercialisation of Bill huge external payment
Market Scheme : deficit.
Under this commercial
banks get additional fund
from RBI to advance
credit further. This will
increase money supply.
Moral Suasion:
Under moral suasion RBI
issues letters to banks to
exercise control over
credit or advance against
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particular commodity or
 Fiscal Policy
Fiscal policy is the policy of
government concerned with
raising of revenue through
taxation and other means
and deciding on the level
and pattern of expenditure
Objectives of Fiscal Policy:
3. To accelerate rate of
investment
4. Achieving rapid economic
development
5. Achieving full employment
6. Promoting foreign trade
7. Establishing welfare state
 Fiscal policy is operated
through Budget
 Fiscal policy also called
‘Budgetary Policy’
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• Instruments of Fiscal
Policy
2. Taxation
3. Public Expenditure
4. Public Debt
Taxation:
6. Direct Tax – Personal
Income tax,Corporation
tax,Inheritance tax,Wealth
tax
2. Indirect tax – Excise duty,
VAT, Customs duty,Sales
tax
To modify the revenue the
govt will increase/Decrease
tax rate or tax base
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 Fiscal Policy
• Instruments of Fiscal Policy Public Debt:
2. Taxation
3. Public Expenditure
4. Public Debt
Public Expenditure:
Rise in public expenditure will
increase the standard of
living
Public expenditure is done
through Budget
The govt. will make following
changes on Public
expenditure
Size of public expenditure
Combination of expenditure
Direction of expenditure
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 The Budget
Budget means an estimate of
Revenue and Expenditure
Importance:
 In India , the total budgetary
expenditure of both Centre &
States is 50% of GDP
 It accelerates economic
development
 Improves production in private
sector
 Improves income distribution
 Promote export & import
substitution
Union Budget-
The anticipated revenue &
expenditure of Central govt.
 It is presented to Parliament on
the last day of February.
 All receipts & disbursements are State Budget-
kept under two headings
namely
Consolidated Fund and
Public Account of India
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 These two accounts are formed
Consolidated Fund – It contains all
revenues received, loans raised and
repayment of loans by the central
govt
- No money can be withdrawn
except under the authority of
parliament
- The estimate of expenditure from
Consolidated Fund are place before
Parliament
- All withdrawals from this fund are
passed as Finance Act seperately.
Public Account – All the revenues not
included in consolidated fund like
deposits, remittances, service funds
go in to this account.
- To withdraw money approval of
parliament is not required
Contingency Fund – To meet
unforseen expenditure , established
under Article 267(I) of Constitution
The anticipated revenue & expenditure
of State & UTs govt.
Placed before Legislature at the
begning of Financial year .
It also contains Consolidated Fund,
Public Account & Contingency Fund
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 The Budget
Sources of Union
Revenue
Income Tax
Customs & Export Duties
Corporation Tax
Excise duties on tobacco &
other goods manufactured in
India
Estate duty on property
Taxes on Railway, air,
Passenger goods
Stamp duty on transactions in
Stock exchange
Taxes on sale or purchase of
news paper & advertisement
Tax not included in State list
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Sources of State
Revenue
Land revenue
Tax on agriculture income
Estate duty on agriculture land
Taxes on land & buildings
Taxes on liquor produced in
India
Taxes on entry of goods
Tax on consumption or sale of
electricity
Tax on sale or purchase of
goods except news paper
Tax on advertisement other
than news paper
Tax on goods & passengers by
road and inland water ways
Tax on
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animal,boat,profession,vehic
 The Budget
Finance Commissions:
Under the Constitution of India Finance
Commission has to be constituted
every five years to make necessary
recommendations to President on
3. Modalities for distribution of tax
between centre and state and
among states
4. Principle for payment of Grant-in-
aids to states
5. Recommendation on continuation or
not of the agreements between
Centre & State
6. Recommend on any other isue
12/14/2008 referred toSurana
it. College PG Centre 10