MONETARY POLICY AND FISCAL POLICY

Monetary Policy –

The process by which the Govt., central bank or monetary authority of country controls –

A.      Supply of money

B.      Availability of money

C.      Cost of money or rate of interest

Monetary policy is referred to as either being an expansionary policy or a contractionary policy

Expansionary policy	Contractionary policy
Increase total supply of money in economy	Decrease the total supply of money
Combat unemployment in a recession by lowering interest rate	Raising interest rate in order to combat inflation

  

Monetary policy is contrasted with fiscal policy, which refer to Govt. borrowing, spending & taxation.

Tools of Monetary policy –

A.      Bank Rate

B.      Cash Reserve Ratio (CRR)

C.      Statutory Liquidity Ratio (SLR)

D.      Market Stabilization Scheme (MSS)

E.       Repo Rate

F.       Reverse Repo

G.     Open Market Operations (OMO)

Bank Rate

Ø  Also refer to discount rate

Ø  The rate of interest which a central bank charges on the loans and advances that it extends to commercial banks and other financial intermediaries.

Ø  Used by central bank to control the money supply

Cash Reserve Ratio (CRR)

Ø  Banks have to maintain with RBI as a certain percentage of their total deposit (net demand & time deposit) in the form of liquid cash.

Ø  When RBI feels that money supply is increasing and causing an upward pressure on inflation, then RBI has option of increasing the CRR thereby reducing the deposit available with bank to make loan and hence reducing the money supply and inflation

Statutory Liquidity Ratio (SLR)

Ø  It refer to the amount that all banks require maintaining in cash or in the form of Gold or approved securities (i.e dated securities, Govt. bonds & share)

Ø  SLR is maintained in order to control the expansion of bank credit.

Ø  SLR is a way to ensure the solvency of commercial banks.

Market Stabilization Scheme (MSS)

Ø  Under this scheme, the Govt. would issue existing instrument such as Treasury Bill & or dated securities by way of auction under MSS

Repo Rate

Ø  The rate at which RBI lends short-term money to the banks

Ø  When Repo rate increases, borrowing from RBI becomes more expensive.

Ø  Bank lending rates are determined by the movement of repo rate

Reverse Repo

Ø  The rate at which bank park their short-term excess liquidity with RBI

Ø  An increase in the reverse repo means that the RBI will borrow money from banks at a higher rate of interest.

Open Market Operation (OMO)

Ø  Under the OMO, RBI buys or sells Govt. bonds in the secondary market.

FISCAL POLICY

Ø  Fiscal policy is the use of Govt. spending & revenue collection to influence the economy.

Ø  The two main instrument of fiscal policy are Govt. spending & taxation.

Ø  Govt. use fiscal policy to influence the level of aggregate demand in economy, in an effort to achieve economic objective of price stability, full employment & economic growth.

FRBM Acts

Ø  (Fiscal Responsibility & Budget Management Acts)

Ø  Committee headed by Dr. E. A. S. Sarma in Jan 2000 to recommended draft legislation on fiscal responsibility.

Ø  Submitted in July 2000, introduce in parliament in Dec 2000 & enacted as law in Aug. 2003.