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Principles of
UNIT III
MACROECONOMIC POLICIES – MONETARY AND FISCAL
BABY THOMAS 2016
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UNIT III –
MACROECONOMIC POLICIES – MONETARY AND FISCAL
1. Meaning of macroeconomic policy, need of macroeconomic
policies
2. Meaning of monetary policy, instruments of monetary
policy
3. Meaning of fiscal policy, instruments of fiscal policy
4. Fiscal policy and macroeconomic goals
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Meaning of macroeconomic policy
• Macroeconomic policy is the set of
government rules and regulations to control
or stimulate the aggregate indicators of an
economy.
• Aggregate indicators involve national income, money
supply, inflation, unemployment rate, growth rate,
interest rate and many more.
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Need of macroeconomic policies
•
A central issue in macroeconomics is whether markets automatically bring
about long run economic equilibrium or not if it is left alone. If the free
operation of market forces eventually resulted in a full employment level of
national income with stable prices and economic growth, there would be no
need for government intervention in the macro economy - no need for fiscal
or monetary policies. The reality is that all governments intervene through
their macroeconomic policies in a bid to achieve certain policy objectives
and improve the overall performance of the economy.
•
Need of macroeconomic policies are:
1.
2.
3.
4.
5.
6.
Sustained economic growth
Stable prices (low inflation)
A high level of employment
A rise in average living standards
Sustainable position on the balance of payments
Sound government finances
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Macroeconomic policies
Macroeconomic policy
is usually implemented
through two sets of
tools:
1. Monetary policy
2. Fiscal policy
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Monetary policy involves the use of
interest rates to control the level
and rate of growth of aggregate
demand in the economy
Fiscal policy involves the use of
government spending, taxation and
borrowing to influence both the
pattern of economic activity and
also the level and growth of
aggregate demand, output and
employment.
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Instruments of Monetary Policy
1.
2.
3.
4.
5.
6.
Bank Rate of Interest
Cash Reserve Ratio
Statutory Liquidity Ratio
Open market Operations
Margin Requirements
Deficit Financing
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Bank Rate of Interest
It is the interest rate which is fixed by the central bank to
control the lending capacity of commercial banks . During
inflation, the central bank 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 (as
cash) which banks have to keep/maintain with the central
bank . During Inflation the central bank increases the CRR
due to which commercial banks have to keep a greater
portion of their deposits with the central bank . This serves
two purposes. It ensures that a portion of bank deposits is
totally risk-free and secondly it enables that the central bank
control liquidity in the system, and thereby, inflation.
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Statutory Liquidity Ratio
Banks are required to invest a 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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Open market Operations
It refers to the buying and selling of Govt. securities in the
open market . During inflation the central bank sells
securities in the open market which leads to transfer of
money to the central bank . Thus money supply is controlled
in the economy.
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Margin Requirements
• During Inflation the central bank 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 the central bank.
If more new notes are printed, it will increase the supply of
money thereby increasing demand and prices.
• Thus during Inflation, the central bank will stop printing new
currency notes thereby controlling inflation.
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Fiscal Policy
• Fiscal policy refers to the revenue and expenditure policy of
the government, which is generally used to cure recession
and maintain economic stability in the country.
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Instruments of Fiscal Policy
1.
2.
3.
4.
Budgetary surplus and deficit
Government expenditure
Taxation- direct and indirect
Public debt
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Budgetary surplus and deficit
• Budgetary surplus and deficit is a fiscal policy instrument An
accumulated deficit over several years (or centuries) is
referred to as the government debt. A deficit is a flow. And a
debt is a stock. Debt is essentially an accumulated flow of
deficits
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Government expenditure
• It includes:
• Government spending on the purchase of goods and
services.
• Payment of wages and salaries of government servants
• Public investment
• Transfer payments
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Taxation
• Non quid pro quo transfer of private income to public coffers
by means of taxes.
• Classified into
• 1. Direct taxes- Corporate tax, Tax, Personal Income Tax,
Fringe Benefit taxes, Banking Cash Transaction Tax
• 2. Indirect taxes- Central Sales Tax, Customs, Service Tax,
excise duty.
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Public Debt
• Internal borrowings:
• Borrowings from the public by means of treasury bills
and govt. bonds
• Borrowings from the central bank ( monetized deficit
financing)
• External borrowings
• foreign investments
• international organizations like World Bank & IMF
• market borrowings
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Fiscal policy and macroeconomic goals
• Fiscal policy refers to the government’s choices regarding the
overall level of government purchases or taxes. Fiscal policy
influences saving, investment, and growth in the long run.
• Fiscal policy affect macroeconomic goals in the following
ways:
1. Economic growth: By creating conditions for savings and investments
2. Employment: By using labor-absorbing technology
3. Stabilization: By fighting with depression trends and booming indications in the
economy
4. Economic equality: By reducing the income and wealth gap between the rich
and the poor
5. Price stability: By containing
inflationary and deflationary tendencies in the
economy
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Principles of
UNIT III
MACROECONOMIC POLICIES – MONETORY AND FISCAL
BABY THOMAS 2016
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