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Intro..

The economic position of a country can be


monitored, controlled and regulated with the
sound economic policies.
The fiscal and monetary policies of the nation
are the two measures, which can help in
bringing stability and developing smoothly.
Fiscal policyis the policy relating to
government revenues from taxes and
expenditure on various projects.
Monetary Policy, on the other hand is mainly
concerned with the flow of money in the
economy.
Monetary policy
Def: Monetary policy is that process by which
monetary authority of a country, generally a
central bank controls the supply of money in the
economy by its control over interest rates in order
to maintain price stability and achieve
higheconomic growth.
Monetary policyis the process by
whichmonetaryauthority of a country, generally
a central bank controls the supply of money in the
economy by its control over interest rates in order
to maintain price stability and achieve high
economic growth.
Contd..
Monetary Policy is a strategy used by the Central
Bank to control and regulate the money supply in
an economy. It is also known as credit policy.
In India, the Reserve Bank of India looks after the
circulation of money in the economy.
There are two types of monetary policies, i.e.
expansionary and contractionary.
The policy in which the money supply is
increased along with minimization of interest
rates is known as Expansionary Monetary
Policy.
On the other hand, if there is a decrease in
money supply and rise in interest rates, that
policy is regarded as Contractionary Monetary
Policy.
Contd.
The main purposes of the monetary policy include
bringing price stability, controlling inflation,
strengthening the banking system, economic growth,
etc.
Themonetary policy focuses on all the matters which
have an influence over the composition of money,
circulation of credit, interest rate structure.
measures adopted by the apex bank to control credit
in the economy are broadly classified into two
categories:
General Measures (Quantitative Measures):
Bank Rate
Reserve Requirements i.e. CRR, SLR etc.
Repo Rate Reverse Repo Rate
Open market operations
Selective Measures (Qualitative Measures):
Credit Regulation
Moral persuasion
Direct Action
Issue of directives
Note..
For the stability of the country,
proper credit control is important.
If bank issues too much credit
money, it leads to inflation, on the
other hand, tight control over this
money may cause depression and
unemployment.
Comparison
BASIS FOR
FISCAL POLICY MONETARY POLICY
COMPARISON
Meaning The tool used by the The tool used by the
government in which it central bank to regulate
uses its tax revenue and the money supply in the
expenditure policies to economy is known as
affect the economy is Monetary Policy.
known as Fiscal Policy.

Administered by Ministry of Finance Central Bank


Nature The fiscal policy changes The change in monetary
every year. policy depends on the
economic status of the
nation.
Related to Government Revenue & Banks & Credit Control
Expenditure
Focuses on Economic Growth Economic Stability
Policy instruments Tax rates and Interest rates and credit
government spending ratios
Political influence Yes No
Key Differences Between Fiscal
Policy and Monetary Policy
The following are the major differences between
fiscal policy and monetary policy.
The policy of government in which it utilizes its
tax revenue and expenditure policy to influence
the aggregate demand and supply for products
and services the economy is known as Fiscal
Policy. The policy through which the central
bank controls and regulates the supply of
money in the economy is known as Monetary
Policy.
Fiscal Policy is carried out by the Ministry of
Finance whereas the Monetary Policy is
administered by the Central Bank of the country.
Fiscal Policy is made for short duration, normally
one year, while the Monetary Policy lasts longer.
Contd..
Fiscal Policy gives direction to the economy. On the
other hand, Monetary Policy brings price stability.
Fiscal Policy is concerned with government
revenue and expenditure, but Monetary Policy is
concerned with borrowing and financial
arrangement.
The major instrument of fiscal policy are tax rates
and government spending. Conversely, interest
rates and credit ratios are the tools of Monetary
Policy.
Political influence is there in fiscal policy, however
this is not with the case of monetary policy.
Fiscal policy
When the government of a country employs
its tax revenue and expenditure policies to
influence the overall demand and supply for
commodities andservices in the nations
economy is known as Fiscal Policy.
It is a strategy used by the government to
maintain the equilibrium between
governmentreceipts through various sources
and spending over different projects.
The fiscal policy of a country is announced
by the finance minister throughbudget
every year.
Contd..
If the revenue exceeds expenditure, then
this situation is known as fiscal surplus,
whereas if the expenditure is greater than
the revenue, it is known asfiscal deficit.
The main objective of the fiscal policy is
to bring stability, reduce unemployment
and growth of the economy.
The instruments used in the Fiscal Policy
are level of taxation & its composition and
expenditure on various projects.
There are two types of fiscal policy, they
are:
Contd..
Expansionary Fiscal Policy: The
policy in which the government
minimizes taxes and increase public
spending.
Contractionary Fiscal Policy: The
policy in which the government
increases taxes and reduce public
expenditure.
Quantitative measures of
MP
Bank rate : A bank rate is the interest rate at which
a nation's central bank lends money to domestic
banks, often in the form of very short-term loans. For
controlling the credit, inflation and money supply, RBI
will increase the Bank Rate.
In order to correct excess demand or inflationary
situations, Central Bank increase bank rate.
Consequent upon an increase in bank rate,
commercial banks raise their lending rate to the
general public. This makes the borrowing from
commercial banks costlier. Therefore, businessmen
and enterprises reduce borrowing and cut investment.
As a result, income of the people declines and
demand for goods is curtailed. In this way, the
situation of excess demand or inflation is checked.
OMO
Open Market Operations: OMO The Open market
Operations refer to direct sales and purchase of
securities and bills in the open market by Reserve bank
of India. The aim is to control volume of credit.
In order to correct the excess demand or inflation, the
central bank sells securities to the commercial banks
and general public. When commercial banks buy
securities, their cash reserves are reduced directly. When
people buy securities, they make large withdraw of cash
from commercial banks. Here their cash reserves are
diminished indirectly. Consequently, commercial banks
capacity to create credit is curtailed. This leads to a
reduction in the volume of investment on the part of
businessmen and entrepreneurs and a decline in
national income. As a result, the state of excess demand
or inflation is checked.
CRR
Cash Reserve Ratio: Cash reserve ratio
refers to that portion of total deposits in
commercial Bank which it has to keep with
RBI as cash reserves.
According to the law, each commercial
bank has to keep a part of its deposits with
the central bank is a ratio known as the
cash reserve ratio (CRR).
If RBI cuts CRR in its next monetary policy
review then it will mean banks will be left
with more money to lend or to invest. So,
more money can be released into the
economy which may spur economic growth
CRR
In order to correct the state of excess demand or
inflation central bank increase the cash reserve
ratio (CRR). So commercial banks are required to
keep larger amount of cash reserves with the
central bank and consequently, amount of cash
available with them is reduced. This leads to a
decline in the credit creating capacity of
commercial banks. When smaller amount of
credit is given to the entrepreneurs, investment
falls. Consequently, national income declines and
the state of excess demand are checked.
Likewise, the central bank can correct the state of
deficient demand or deflation by reducing the
cash reserve ratio (CRR).
CRR
SLR
Statutory Liquidity Ratio: It refers to that
portion of deposits with the banks which it
has to keep with itself as liquid assets(Gold,
approved govt. securities etc.) . If RBI
wishes to control credit and discourage
credit it would increase CRR & SLR.
Banks have to invest certain percentage of
their deposits in specified financial
securities like Central Government or State
Government securities. This percentage is
known as SLR.
Contd..
This money is predominantly invested in
government approved securities (bonds),
Gold, which mean the banks can earn some
amount as 'interest' on these investments as
against CRR where they do not earn
anything.
Example - An Individual deposits say Rs 1000
in bank. Then Bank receives Rs 1000 and
has to keep some percentage of it with RBI
as SLR. If the prevailing SLR is 20% then
they will have to invest Rs 200 in
Government Securities
SLR+CRR

Higher reserve requirements such as SLR make banks relatively safe (as a
certain portion of their deposits are always redeemable) but at the same time
restrict their capacity to lend. To that extent, lowering of reserve requirement
increases the resources available with a bank to lend and helps control inflation
and propels growth.
Repo and reverse repo rates
Repo rate is the rate at which our banks borrow rupees
from RBI. Whenever the banks have any shortage of
funds they can borrow it from RBI. A reduction in the
repo rate will help banks to get money at a cheaper
rate. When the repo rate increases, borrowing from RBI
becomes more expensive.
When we need money, we take loans from banks. And
banks charge certain interest rate on these loans. This
is called as cost of credit (the rate at which we borrow
the money).
Similarly, when banks need money they approach RBI.
The rate at which banks borrow money from the RBI by
selling their surplus government securities to RBI is
known as "Repo Rate." Repo rate is short form of
Repurchase Rate. Generally, these loans are for short
durations up to 2 weeks.
Contd..
It simply means Repo Rate is the rate at which RBI
lends money to commercial banks against the pledge
of government securities whenever the banks are in
need of funds to meet their day-to-day obligations.
Example - If repo rate is 5% , and bank takes loan of Rs
1000 from RBI , they will pay interest of Rs 50 to RBI.
So, higher the repo rate higher the cost of short-term
money and vice versa.
Higher repo rate may slowdown the growth of the
economy.
If the repo rate is low then banks can charge lower
interest rates on the loans taken by us.
What is Reverse Repo Rate?
This is exact opposite of Repo rate. Reverse Repo rate
is the rate at which Reserve Bank of India (RBI)
borrows money from banks. RBI uses this tool when it
feels there is too much money floating in the banking
system. Banks are always happy to lend money to
RBI since their money is in safe hands with a good
interest. An increase in Reverse repo rate can cause
the banks to transfer more funds to RBI due to this
attractive interest rates.
Reverse repo rate is the rate of interest offered by
RBI, when banks deposit their surplus funds with the
RBI for short periods. When banks have surplus
funds but have no lending (or) investment
options, they deposit such funds with RBI.
Banks earn interest on such funds.
Impact of Repo Rate
/CRR/SLR rate cut
Current Rates
Current rate
CRR 4.000%
SLR20.50%
Repo rate 6.25%
Reverse repo rate5.75%
Qualitative credit control
measures include:
(i) Prescription of margin
requirements
(ii) Consumer credit regulation
(iii) Moral suasion
(iv) Direct action
Prescription of margins

requirements
Generally, commercial banks give loan against stocks or
securities. While giving loans against stocks or securities
they keep margin. Margin is the difference between the
market value of a security and its maximum loan value. Let
us assume, a commercial bank grants a loan of Rs. 8000
against a security worth Rs. 10,000. Here, margin is Rs.
2000 or 20%.
If central bank feels that prices of some goods are rising due
to the speculative activities of businessmen and traders of
such goods, it wants to discourage the flow of credit to such
speculative activities. Therefore, it increases the margin
requirement in case of borrowing for speculative business
and thereby discourages borrowing. This leads to reduction
is money supply for undertaking speculative activities and
thus inflationary situation is arrested.
Contd..
On other contrary, central bank can encourage
borrowing from the commercial banks by
reducing the margin requirement. When there
is a grater flow of credit to different business
activities, investment is increased. Income of
the people rises. Demand for goods expands
and deflationary situation is controlled.
Thus, margin requirement is a significant tool
in the hands of central bank to counter-act
inflation and deflation.
Consumer credit
regulation
Now-a-days, most of the consumer durables like T.V.,
Refrigerator, Motorcar, etc. are available on installment
basis financed through bank credit. Such credit made
available by commercial banks for the purchase of
consumer durables is known as consumer credit.
If there is excess demand for certain consumer durables
leading to their high prices, central bank can reduce
consumer credit by (a) increasing down payment, and (b)
reducing the number of installments of repayment of
such credit.
On the other hand, if there is deficient demand for
certain specific commodities causing deflationary
situation, central bank can increase consumer credit by
(a) reducing down payment and (b) increasing the
number of installments of repayment of such credit.
Moral suasion

Moral suasion means persuasion and request. To


arrest inflationary situation central bank
pursuades and request the commercial banks to
refrain from giving loans for speculative and non-
essential purposes.
Central bank also appeals commercial banks to
extend their wholehearted co-operation to
achieve the objectives of monetary policy. Being
the monetary authority directions of the central
bank are usually followed by commercial banks.
Direct Action

This method is adopted when a commercial bank


does not co-operate the central bank in achieving
its desirable objectives. Direct action may take any
of the following forms:
Central banks may charge a penal rate of interest
over and above the bank rate upon the defaulting
banks;
Central bank may refuse to rediscount the bills of
those banks which are not following its directives;
Central bank may refuse to grant further
accommodation to those banks whose borrowings
are in excess of their capital and reserves.

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