Monetary & Fiscal Policy

Module - 5

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 Monetary Policy
 Monetary policy is a policy
statement through which the
central bank ( RBI )
targets key set of indicators
to ensure price stability in
the economy.
 These indicators include
• Money supply ( M3)
• Interest rate
• Inflation
 This policy is announce d
twice in a year during April &
October
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Extent of Money:
The central bank measures the
extent of money & credit
available in the economy using
the indices like M0,M1,M2,M3.
The sources of M3 are :
Bank credits, Govt.’s currency
liability to public , net foreign
exchange reserves of banks.
Expansion of Money
Supply:
Money supply in the economy will be
increased by RBI through issue of
currency, budgetary operations
and borrowings by govt. from
foreign countries.
Growth in money supply should be
more than the growth in real
national income. If money supply
is exorbitantly more will result in
inflation.
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 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
• Fixing ceiling on certain credits
• Charging discriminatory interest on
certain credits
• Moral suasion
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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.
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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 supply and sells gold and
securities to contract money
supply.
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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 issue
credit facility to Small scale 1. To reduce inflation by
industries, self employed etc. . This contracting money supply
will increase money supply and vice
versa to reduce the money supply 2. To print new currency
Commercialisation of Bill with a view to reduce the
Market Scheme : trade deficit
Under this commercial banks get 3. Boosting export to reduce
additional fund from RBI to
advance credit further. This will huge external payment
increase money supply. deficit.
Moral Suasion:
Under moral suasion RBI issues
letters to banks to exercise
control over credit or advance
against particular commodity or
unsecured advances to increase
or decrease money supply

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 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:
1. To accelerate rate of investment
2. Achieving rapid economic
development
3. Achieving full employment
4. Promoting foreign trade
5. Establishing welfare state
 Fiscal policy is operated through
Budget
 Fiscal policy also called
‘Budgetary Policy’
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• Instruments of Fiscal
Policy
1. Taxation
2. Public Expenditure
3. Public Debt
Taxation:
1. 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:
1. Taxation
2. Public Expenditure
3. 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
kept under two headings namely
Consolidated Fund and
Public Account of India
 These two accounts are formed
under Annual Appropriation Act.
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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
State Budget-
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
animal,boat,profession,vehicles,
entertainment, gambling
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 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
1. Modalities for distribution of tax
between centre and state and among
states
2. Principle for payment of Grant-in-aids
to states
3. Recommendation on continuation or
not of the agreements between
Centre & State
4. Recommend on any other isue
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