1. FISCAL POLICY
Fiscal policy refers to a policy under which
government uses its expenditure and revenue
programs to produce desirable effects and avoid
undesirable effects on the national income,
production and employment.
Prior to the Great Depression of 1930s, the govt.
all over the world played a passive role in
economic activities. But as the notion of ‘Welfare
State’ was accepted, the govts. started involving
themselves in economic activities to bring about
economic growth and equality, through the
adoption of appropriate fiscal policies.
3. 1) Attainment of Full Employment
The objective of full employment is achievable when there is
sufficient increase in aggregate DD. an increase in govt. exp. pushes
up aggre.DD, which will lead to increase in N.I and employment.
2) Maintenance of Price stability and Economic Stability
Fiscal policy should be able to counteract the cyclical fluctuations.
During depression-increase pub.exp. and decrease tax rates.
During inflation-reduce public exp.and increase taxes to reduce the
purchasing power in the hands of the people.
3) Increasing the rate of capital formation
This is to increase the rate of investment.-Restrict consumption &
push up saving- govt. resorts to taxation and public borrowing .In low
income countries govt.may resort to indirect taxes.
4. 4) Developing a Socially Optimum Pattern of investment.
It varies from country to country.Some countries may aim at
investment in socio – economic overheads like transport ,power etc.
Some others may invest in basic and heavy industries.
5) Minimising Inequalities in Income and wealth.
Govt. may tax on a progressive rate- Indirect taxes- heavy on
luxury goods & light on necessary goods
Govt. should undertake welfare activities to the poorer section of pop.
6) Reducing Unemp.& Under Emp.
Introduce specific pub.exp. progrs.like building bridges,roads,etc.in
urban areas- building schools, hospitals etc. in rural areas.
5. TOOLS OF FISCAL POLICY
1)Taxation: Changes in tax rates bring about changes in disposable
incomes & levels of income.
During inflation-Increase tax rates & introduce new taxes.
Deflation- a reduction in tax burden to stimulate consumption &
investment.
2)Pub.Exp: If pvt.investment is insufficient, govt. should spend
enough to fill the deflationary gap. If pvt. Investment is inflationary;
govt. should spend less to wipe out the inflationary gap.
6. If the pvt. Sector is shy to invest in certain sectors like basic
industries, infrastructure, power etc., the govt should step in & spend
huge amount – known as’ compensatory spending’.
At times pub. Exp. May be necessary to correct temporary
maladjustment in the economy and make it work smoothly.
Such method is known as pump priming.
Modern govts. Spend a lot on welfare measures like free health
services, pensions etc. so govts. Spend more.
3)Pub.Debt: Pub.borrowing & Pub.repayment are useful to fight
inflation & deflation.inflation- repayment & deflation-borrowing.
4)Deficit Financing: When pub.exp. is more than pub. Revenue.
It means filling the budgetary gap through loans. It also means
Printing more currency by C.B. & putting into circulation.
During deflation, it is used widely to increase pub.exp.to induce an
expansion in employment, consumption, employment.etc.
It is also used to reduce the intensity of business cycles.
It is known as compensatory fiscal policy.
7. Budget Analysis: It is used to fight inflation, deflation and stablise
the economy.it consists of deliberately managing the budget to adjust
pub. revenue, exp., and debt in such a way as to achieve full
employment without inflation.
LIMITATIONS
Whenever legislative sanctions are required, there may be delays in
implementing.
Accurate forecasting of future course of business cycle is essential
for effective implementation.
Time lag b/n initiation & realization.
An increase in pub. Investment may be followed by a decline in
pvt.investment.
It may be inadequate in dealing with run away inflation & deep
depression.
8. MONETARY POLICY
Monetary policy is adopted by the central bank.
It’s the ‘management of the expansion and contraction of the
volume of the money in circulation for the explicit purpose of
attaining a specific objective such as full employment’ R P Kent.
Objectives
9. 1)Price stability
When prices rise the fixed income group gets adversely affected and
when it falls the producers and business men get affected.
Price stability ensures steady growth in production and employment.
A few economist advocates that a mild inflation is really conducive for
economic growth
2)Stability of foreign exchange
It’s to minimize fluctuations in foreign receipts and payment and their
by maintain a reasonable balance in their balance of payments.
If disequilibrium then deliberates changes are resorted in exchange
rates.
3)Full employment
Monetary policy should aim at solving unemployment problem by
expanding consumption and investment expenditure.In order to
increase investment borrowings may be stimulated by following
cheap money policy.If investment falls economy may experience
deflation.In development countries where there is an imbalance
between supply of labour and supply of other resources, full
employment of labour is not feasible and may opt for optimum
10. 4) High rate of economic growth.
Economic growth means qualitative and quantitative increase in
goods and services in an economy. To ensure this adequate credit
will have to be year marked.
Many developing countries allow the money supply to slightly exceed
the demand for money so that there is a small increase in price which
is conducive for economic growth.
5) Equitable distribution of income.
For this credit policy can be organized in such a way so as to provide
more credit to the poor and help them purchase productive assets.
This may also help in tackling the problems of unemployment and
Poverty
12. 1) General or Quantitative methods of credit control
There are 3 methods
a)Bank rate
• It refers to the rate of interest which the central bank re-
discounts approved bills of exchange.
• When bank rate is changed other interest rates in the
market also invariably responds to its changes.
• Whenever the central bank raises the bank rate other
interest rates rise and borrowing becomes less attractive
and leads to contraction of credits.
• A reduction in bank rate reduces all other market rates of
interest making borrowing more attractive and resulting in
the expansion of credits.
13. Limitations
•Modern banks have become financially self reliant so that they
don’t depend much on central bank for obtaining financial
accommodation
•There is no flexibility in the money market, quantity of money and
credit does not show many responses to bank rate.
•The menace of parallel economy
•The development of alternative and more effective methods.
•Rendering the bank rate policy in effective
14. b) Open market operations
It refers to buying and selling of other securities by the central
bank. During inflation the central banks sells securities and tries to
contract the quantum of money. During deflation the central bank
buys the securities and tries to expand credit.
Limitations
1)The effectiveness of this method depends to a great extend on
the demand for and supply of government securities.When it tries
to sell the securities, the demand for them may be very less when
it tries to sell the securities, the supply may be less.
2)During depression, this method becomes in effective as there is
very little demand for credit by the borrowers for the purpose of
investment.
3)When people use hooded money or income received from
abroad to purchase the securities, this method becomes
ineffective.The success of this method depends on the existence
of a well eveloped money and capital market.
15. c)Variable Statutory reserve ratio
Under this method the central bank varies the statutory cash
reserve requirements of the commercial banks. During inflation, it
will raise the reserve ratio which will reduce the funds available for
loans and hence lead to a reduction in credit. A decline in reserve
ratio means that the banks will now have excess reserves and this
will help them to create more credit.
ii) Selective or qualitative methods.
They aim at curtaining the flow of credit into unproductive channels
and diverting them into productive channels of credit.
a)Rationing of credit
It is to restrict credit to certain sectors or sections
b)Variable margin requirements
Margin means the difference between the value of a security and
the amount of loan which can be availed on that security. If the
margin requirement is raised, he can get only a lower amount as
loan and vice versa.
16. c) Regulation of consumer credit
This measure is resorted to restrict consumer demand for credit. The
bank may be asked to charge higher rates of interest on consumer
durables to discourage borrowing by the consumer.
d) Deficit financing
This method is adopted to cover the budgetary gap and brings more
notes to cover the deficit which results in inflation and purchasing
power in the hands of the people increases but production of goods
and services do not increase.
e) Moral suasion
This is to urge the commercial banks to adopt certain restrictive
practices voluntarily.
f) Direct action
They are punitive measures like denial of rediscounting facility,
charging penal rates of interest etc against those banks which have
committed errors.
17. LIMITATIONS
1)There is a lot of time lag between the recognition of the need for
action and actual implementation of the policy decisions.
2)The existence of a large number of financial intermediaries in
money and capital market over which the central bank has no
control has rendered the policy in effective.
3)There may be contradictory objectives to be followed by a
central bank in an economy and the attainment of one may be
possible only at the expense of the other.
Growth with stability is very difficult to achieve. In many
developing countries money and capital markets are under
developed and un-organized which makes it very difficult to
expand or contract money according to the needs of the economy.
4) The ineffectiveness of some of the instruments of credit control
