The document discusses monetary and fiscal policy as tools for economic stabilization. It explains that economic stabilization aims to maintain high levels of output, employment, and living standards. Monetary policy, implemented by central banks, uses tools like interest rates, reserve requirements, and open market operations to influence money supply and credit. Fiscal policy, set by governments, utilizes taxation, spending, debt, and deficit financing to impact production, income distribution, and resource allocation. Both policies seek to achieve full employment, price stability, and economic growth, adjusting their instruments as needed for inflationary or deflationary conditions.

1. Monetary & Fiscal
Policy

2. Economic Stabilization
• Economic stabilization is a major target of all govt.
• Modern Economies perform a variety of functions to ensure high
level of socio economic welfare
• Development of various sectors of economy, improving std of
living, maintaining high level of employment & income etc. are
prime objectives of modern govt
• Stabilizing economy at high level of output & employment is most
important concern of govt & is known as Economic Stabilization
• Macro Economic Policy guides govt in attaining economic
stability

3. Economic Stabilization
• Objectives of macro economic policy
– Attain full employment & ensure high level of output
– Maintain Price Stability
– Accelerating rate of economic growth
• Instruments of Macro Economic Policy
– Monetary Policy
– Fiscal Policy

4. Monetary Policy
• It is concerned with money supply, credit creation in the
market & rate of interest
• Formulated & implemented by Central Bank i.e. RBI
• By controlling money supply & credit creation, stability can be
ensured in an economy
• At present, combination of monetary & fiscal policy is used to
achieve objectives of macro economic policy
• The objectives differ from country to country & from time to
time
• It depends upon the stage of development & economic situation
in the economy during a particular time

5. Objectives of Monetary Policy
• Monetary Policy & Economic Growth
– High N.I. – Capital Formation should be high – providing
capital to investors at the right time at reasonable rates –
During Inflation Dear Money Policy – Deflation Cheap Money
Policy
• Monetary Policy & Price Stability
– Controlling fluctuations in price – should take care that
growth is not affected

6. Objectives of Monetary Policy
• Monetary Policy & Full Employment
– Productive resources are fully employed – high level of
output & income – increase in std of living
• Monetary Policy & Exchange Rate Stability
– Till 1970’s it was emphasized by monetary policy –
considered imp for int trade & control movement of
capital - at present it is secondary & many nations prefer
flexible exchange rate so that adjustments can be made as
per requirements

7. Instruments of Monetary Policy
• Quantitative Instruments
– Also known as General Credit Control
– Helps to control the quantity of credit
• Qualitative Instruments
– Controls the direction of credit

8. Quantitative Instruments
• Bank Rate
– Rate @ which central bank discounts the securities of
commercial banks
– It influences the cost of credit
– During inflation central bank increases the bank rate
thereby, making credit costlier & during deflation it is
decreased

9. Quantitative Instruments
• Open Market Operations
– Refers to buying & selling of govt securities by central bank
– During inflation there is too much money in the market, bank
will sell securities to commercial banks thereby reducing their
cash reserves & reducing their credit formation
– During De4flation it buys securities from commercial banks to
increase their cash reserve & thereby increasing their credit
creation capacity

10. Quantitative Instruments
• Cash Reserve Ration (CRR)
– Commercial banks have to keep a % of their deposits with central
bank to ensure liquidity & solvency of the bank
– During Inflation, the CRR is increased to reduce their capital &
during deflation it is reduced
• Statutory Liquidity Ratio (SLR)
– Refers to ratio of liquid assets to net demand liabilities and time
liabilities
– Time liabilities are liabilities which the banks are liable to pay after
a certain period of time. E.g. A 1 year fixed deposit
– Demand liabilities are liabilities which the banks are liable to pay on
being demanded by the customer. E.g. A savings account

11. Quantitative Instruments
• Repo Rate
– Refers to repurchase option – securities are sold by the seller to the
investor with an agreement to repurchase at a predetermined rate &
date i.e. Rate at which central bank gives loans to commercial banks
against their securities
– During inflation, repo rate is increased & deflation it is reduced
• Reverse Repo
– Rate at which central bank borrows from commercial banks
– Repo helps to inject liquidity into the market, reverse repo helps to
absorb it from market

12. Qualitative Instruments
• Also known as selective credit control
• Used to control the flow of credit to particular
sector of economy i.e. the direction is controlled
• It is used as complementary to quantitative credit
control technique to discourage flow of credit to
unproductive sectors

13. Qualitative Instruments
• During inflation, central bank takes below steps
– Increase Bank Rate
– Sell Securities
– Increase Cash Reserve Ratio
– Rises the margin requirements
– Control credit for unproductive purpose or sectors

14. Fiscal Policy
• Fiscal policy is formulated & implemented to achieve
pre-determined objectives
• It is concerned with Public Revenue, Expenditure &
Debt
• Govt can influence production, distribution,
consumption & resource allocation through it
• Through Fiscal Policy economic growth &
development can be accelerated

15. Fiscal Policy - Objectives
• Optimum Utilization of Resources
• Increase demand & thereby achieve full
employment & maintain it
• Ensure Price Stability
• Equality in distribution of income & wealth

16. Instruments of Fiscal Policy
• Taxation
– Govt imposes direct & indirect taxes
– It is levied on the principle to pay i.e. rich people pay more tax
than the poor people
– Through taxation, govt can influence production,
consumption, distribution & allocation of resources
– Tax incentives are given to produce mass consumption goods,
certain prod have low tax rates where as harmful products
have high taxes
– Various regions have various tax rates

17. Instruments of Fiscal Policy
• Public Expenditure
– Govt incurs various types of expenditures viz admin expenses, defence,
development of agriculture, transport, communication, subsidy, interest
payment etc.
– It needs to be productive in nature to have +ve effect on economy
– E.g. Spending on education, health, social security like old age pension,
unemployment allowances, provide subsidy to essential products etc.
– It can reduce inequality in distribution of income etc.
– If it is unproductive then economy will have adverse effect like
inflation, shortage of products, inappropriate allocation of resources
etc.
– Effect of public expenditure depends upon the way it is incurred

18. Instruments of Fiscal Policy
• Public Debt
– When the expenditure of govt exceeds its revenue it can resort to
public debt
– It can also be helpful to finance a war or meet unexpected
expenditure like natural calamity etc.
– Useful to control inflation
– Funds borrowed should be utilized for productive purposes like
development of infrastructure, industrial sector, etc. So that these
debts can become self financing i.e. the projects start yielding money
& can repay for themselves
– Thus economic growth can be accelerated through public debt

19. Instruments of Fiscal Policy
• Deficit Financing
– Used when govt expanses are higher than its income
– Refers to borrowing of funds from central bank
– Securities are issued by govt against which currency
notes are provided by central bank
– Deficit financing leads to more money supply leading
to increase in demand for goods & services – if no
proper supply it will lead to inflation

20. Fiscal Policy During Inflation & Deflation
• To control inflation generally govt adopts a surplus budget policy
• It either increases the taxes or govt expenditure if reduced or both are
implemented at same time
• Policy adopted is called as contractionary fiscal policy
• Taxation is used by govt to control price rise i.e. rich people are taxed
more than poor people
• Govt can increase direct tax like income tax or wealth tax thereby
reducing their disposable income leading to less demand of goods &
services & hence price can be stabilized
• Public expenditure can also be used to control inflation i.e. by reducing
unproductive expenses like war, admin expenses etc.
• It is not easy to reduce expenses but govt should make an effort to do so.

21. Questions
1. Explain Economic Stabilization and objectives of
Macro Economic Policy
2. Explain Monetary Policy & its objectives
3. Throw light on Instruments of Monetary Policy
4. Discuss Fiscal Policy and its instruments