2. Introduction
In many countries, monetary policy has been subservient to fiscal policy
Leads to inflationary bias
In recent times there has been modernization of markets leading to efficient
overall policy design and implementation
Issues:
- The overall policy mix as well as each individual policy must be set on a
sustainable course
- Monetary and fiscal policy operate in different time frames
3. The need to coordinate
Objective of macroeconomic policy – sustainable economic growth in a
context of price stability and viable external accounts
Lack of coordination could lead to high interest rates, inflation, exchange
rate pressures, in other words - financial instability
However both the policies are framed by different bodies with its own
objectives, resources, constraints and incentives
Coordination helps achieve the objectives
Eliminates the problem of time inconsistency in the design of monetary policy
A weak policy stance in one policy area burdens the other area and is
unsustainable in the long-run
4. Should be sustainable
Each policy should have credibility. The stabilization of expectations through
monetary policy can only be successful if public finances do not give rise to
destabilizing expectations
Due to different time frames- monetary policy has to bear the burden of ‘fine
tuning’ the stabilization process
Have to coordinate at two levels-
1) Need to address the constraints that arise in the short term
2) Long-term macroeconomic effects that could arise from an unbalanced policy-
mix
5. Interaction
Main sphere of interaction – financing of the budget deficit and monetary
management
There are 4 alternative sources for financing Government deficit:
1) Voluntary private sector purchases of the Government debt in the domestic
market
2) Foreign borrowing
3) Forced placement of Government debt
4) Transfer of resources from the Central bank
Indian Government mainly depends on RBI to finance its deficit
It finances the deficit through Treasury bills
6. Optimal coordination
FA’s objective is to raise short-run growth, it is more effective in reducing
inflation.
The MA’s objective is low inflation, but its policies have a greater effect on
demand-led growth
Optimal monetary-fiscal coordination therefore requires both to work
together to shift the AS downwards
supply-side reforms are required in governance, land and labour markets
7. Indian Policy History
RBI was nationalized at independence, but under the constitution and the
division of responsibilities, if the RBI said no to the finance minister, the
government would have to go to Parliament, which could assert some
discipline on the government
The initial jockeying between the RBI and the Ministry of Finance made it
clear the RBI was to be regarded as a department of the government
Since the RBI had to support the Government it acquired tools to reduce
credit to the private sector
Bank fought for and got additional powers in 1956, by expanding section 42 of
the RBI Act, to give it control over banks’ cash reserves
Oil price shocks increased deficits
8. LPG reforms
WMA, liberalized interest rates
RBI gained greater independence
In 2014 the new government committed to reducing FDs
Focus was now on structural reform
