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Monetary and Fiscal Policy

Monetary and Fiscal Policy

Countries worldwide are concerned about the following issues while setting up monetary and fiscal policies; namely, the appropriate level of aggregate demand and the best blend of monetary and fiscal mix. Monetary policy focuses on the movement of money within the country, the inflow of foreign exchange and varying interest rates fixed by the Reserve Bank. Fiscal policies are concerned about stabilizing the economy and handle public revenue, expenditure and debts. The pattern of resource allocation and distribution of income affect the drafting of fiscal policies. Monetary policy is very well restricted by the government’s decision on public expenditure and taxation. The tactical combination of both will help determine the composition of GDP.

The purpose of monetary policy:

The purpose of monetary policy is to ensure availability of credit to the productive sectors of the economy and also regulation of money supply. Econometric models, which use statistical techniques to assess the impact of monetary policy changes on the macro economy, usually find that changes in money supply have a major impact on production in the short term, with greater impact on the proportion of nominal GDP in terms of wage and price inertia as time progresses. Annual budgets are always a nightmare for the common people as tax imposed on commodities has a say on their disposable income. For example, if the price of crude oil is on the rise, the government can do nothing but to increase the fuel prices. Inflation leads to an increase in interest rates charged by banks nationalized or private, affecting small-and medium-scale business firms.

Monetary and Fiscal Policies are used in various combinations to direct a country's economic goals.

Monetary and Fiscal policy are often targeted to effect inflation.

Some terminologies related to monetary policy:

Let us get ourselves familiar with some of the terminologies in connection with monetary policy. This may help you to understand the subject in a better way.

  • Repo rate: Rate at which RBI lends to other banks against securities
  • Reverse Repo Rate: Rate at which RBI borrows from other banks
  • Cash Reserve Ratio (CRR): Amount of money to be set aside by the banks with RBI against their deposits
  • Statutory Liquidity Ratio (SLR): Percentage of bank funds to be maintained in government securities
  • Capital Adequacy Ratio: Capacity of banks to work within the time line and risks.
  • Bank Rate: Minimum interest rate at which the Central Bank offers commercial loans to other banks
  • Inflation: Steady rise in prices of commodities
  • Money Supply: Sum total of money circulating in the economy

Money flow, policy variables and liquidity conditions have a direct bearing on savings, investment, consumption, inflation, employment and GDP.The ability of a country to improve its standard of living over time depends almost entirely on its ability to improve technology and capital used by the workforce. In short, the budget deficit should be reduced, which guarantees the rate of national savings and increased purchasing power parity (PPP).

Main objectives of monetary policy:

There have been changes in the objectives of monetary policy from time to time and vary from country to country. Sometimes the monetary policy adopted by a country may have different objectives, which are contradictory. In such cases, the country may have to compromise by setting the priorities.

Some of the main objectives of monetary policy:

• Price stability

• Exchange rate stability

• Full employment

• High rate of economic growth

• Equitable distribution of income

Main objectives of Fiscal Policy:

Post the Great Depression of the 1930s, it was well realized that governments should actively participate in economic activities to achieve economic growth and equity, through sound fiscal policies. The purpose of fiscal policy lies in:

• Achieving full employment

• The maintenance of stability

• Increasing the rate of capital formation

• Development of a model of the socially optimal investment

• To minimize inequalities in income and wealth

• Reduce unemployment

It is not enough for a nation to blow its own horn on having a high GDP rate. The bottom line is to see if it has really created the desired effect in reducing poverty and unemployment.Policies aimed at increasing national wealth must take into account the fact that the wealth of a nation extends beyond business investment to other forms of tangible wealth, especially human capital, and countries which are highly populated should try to use this resource to their maximum advantage.

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