GLOBONOMICS & CONTEMPORARY MACRO ECONOMIC ISSUES

MONETARY POLICY & FISCAL POLICY MONETARY AND FISCAL POLICIES

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Monetary Policy
Monetary policy is the process by which the monetary authority of a country controls the i. supply of money, ii. availability of money, and iii. cost of money or rate of interest It rests on the relationship between the rates of interest, that is, the price at which money can be borrowed, and the total supply of money.
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Monetary Policy
It aims to attain a set of objectives oriented towards the growth and stability of the economy. The official goals usually include relatively stable prices and low unemployment.

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Expansionary Monetary Policy

An expansionary policy increases the total supply of money in the economy more rapidly than usual It decreases the interest rate Therefore consumers save less and opt for current consumption over future consumption. This, in turn, causes demand to strengthen. It is intended to slow down unemployment

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Contractionary Monetary Policy

A contractionary policy expands the money supply more slowly than usual or even shrinks it. It raises the interest rate Consumers find it more lucrative to save than spend reducing aggregate demand It is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values.

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INSTRUMENTS OF MONETARY POLICY

1. 2. 3. 4. 5. 6. 7. 8. 9. Open Market Operations Bank Rate Cash Reserve Ratio Statutory Liquidity Ratio Margin Requirements Deficit Financing Credit Control Moral Suasion Exchange Rate

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Open Market Operations

It refers to the buying and selling of Govt. securities in the open market. During inflation, RBI sells securities in the open market which leads to transfer of money to the RBI. Thus money supply is reduced in the economy thereby reducing aggregate demand

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Bank Rate
It is the interest rate at which the RBI lends to the Commercial banks . During Inflation , RBI increases the bank rate of interest due to which borrowing power of commercial banks reduces which thereby reduces the supply of money or credit in the economy . When Money supply reduces, it reduces the purchasing power and thereby curtailing Consumption and lowering Prices.
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Cash Reserve Ratio

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

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

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

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Deficit Financing
It means printing of new currency notes by Reserve Bank of India . This will increase the supply of money thereby increasing demand and prices.
Thus during Inflation, RBI will stop printing new currency notes thereby controlling inflation.
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Credit Control
The Central Bank can direct banks on the maximum percentage or amount of loans (credit ceilings) to different economic sectors or activities, interest rate caps, liquid asset ratio and issue credit guarantee to preferred loans. In this way the available saving is allocated and investment is directed in particular directions.
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Moral Suasion
The Central Bank issues licenses or operating permit to banks and also regulates the operation of the banking system. It can therefore, persuade banks to follow certain paths such as credit restraint or expansion, increased savings mobilization and promotion of exports through financial support, which otherwise they may not do, on the basis of their risk/return

assessment.
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Exchange Rate
By selling or buying foreign exchange, the Central Bank ensures that the exchange rate is at levels that do not affect domestic money supply in an undesired direction, through the balance of payments and the real exchange rate. The real exchange rate when misaligned affects the current account balance because of its impact on external competitiveness.
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Fiscal Policy
It refers to the Revenue and Expenditure policy of the Govt. Through changes in its expenditure and taxes, the government attempts to increase or decrease output and income and seeks to stabilise the ups and downs in the economy. In the process, fiscal policy creates a surplus (when total receipts exceed expenditure) or a budget deficit(when total expenditure exceed receipts) rather than a balanced budget (when expenditure equals receipts).
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Macroeconomic Goals
Economic Growth: By creating conditions for increase in savings & investment Employment: By encouraging the use of labour-absorbing technology Stabilization: fight with depressionary trends and booming (overheating) indications in the economy Economic Equality: By reducing the income and wealth gaps between the rich and poor. Price stability: employed to contain inflationary and deflationary tendencies in the economy.
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Instruments of Fiscal Policy

Govt. Expenditure Taxation Govt. Borrowing

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Govt Expenditure
The expenditures of the government can promote economic activity and create jobs. For example, if the government funds a project to build a high-speed train across the country, the funds that go into the project could go toward hiring workers which could reduce unemployment and inject money into the economy. Higher levels of government spending tend to promote employment and economic growth.
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Taxation
When the government increases or decreases taxes, it increases or decreases the amount of money consumers have to spend which can have a significant impact on the direction of the overall economy. Cutting taxes is a common fiscal policy measure to encourage economic growth.

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The Multiplier Effect

Government purchases are said to have a multiplier effect on aggregate demand. Each dollar spent by the government can raise the aggregate demand for goods and services by more than a dollar. The multiplier effect refers to the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending.
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The Crowding-Out Effect

Fiscal policy may not affect the economy as strongly as predicted by the multiplier. An increase in government borrowing causes the interest rate to rise. A higher interest rate reduces investment spending. This reduction in demand that results when a fiscal expansion raises the interest rate is called the crowding-out effect. The crowding-out effect tends to dampen the effects of fiscal policy on aggregate demand.
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Consideration
When the government increases its purchases by $20 billion, the aggregate demand for goods and services could rise by more or less than $20 billion, depending on whether the multiplier effect or the crowding-out effect is larger.

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Govt Borrowing
Method to mobilize savings of the community for economic development. Public borrowing becomes necessary because taxation alone cannot provide sufficient funds for economic development. Besides, too heavy taxation has an adverse effect on private saving and investment.
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