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Unit12
Structure
12.1 Introduction Objectives 12.2 Conceptsofeconomicstability 12.3 Differentinstrumentsofeconomicstability SelfAssessmentQuestions1 12.4 Monetarypolicy 12.6.1 12.6.2 12.6.3 12.6.4 Objectivesofmonetarypolicy Instrumentsofmonetarypolicy Monetarypolicytocontrolinflation Monetarypolicytocheckdeflation SelfAssessmentQuestions2 12.5 Fiscalpolicy 12.6.1 12.6.2 12.6.3 12.6.4 Instrumentsoffiscalpolicy Objectivesoffiscalpolicy Fiscalpolicytocontrolinflation Fiscalpolicytocontroldepression SelfAssessmentQuestions3 12.6 Physicalpolicyordirectcontrols 12.6.1 Instrumentsofphysicalpolicy SelfAssessmentQuestions4 12.7 Summary

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TerminalQuestions AnswertoSAQsandTQs

12.1.Introduction Macro economics deals with such aggregates which influence and mould economic growth. The studyofaggregatedemand,Aggregatesupply,aggregatesaving,aggregateinvestment, aggregate output, aggregate income, aggregate employment, money supply, inflation, deflation etc. give an insight into thefunctioning of an economy. It also includespolicies such as monetary policy,fiscal policy, exchange rate policy, physical control etc. to achieve growth with stability and to maintain stableconditionsintheeconomy.Economicdevelopmentisnotasmoothupwardmarchandthere willbemanyjerksandjoltsintheprocess,necessitatingvariouskindsofcorrectivemeasures. LearningObjectives: Afterstudyingthisunit,youshouldbeabletounderstandthefollowing

1. Tounderstandandappreciatethemacroeconomicgoalssuchasattainmentoffullemployment,
increasing the level of national income, level of output, promoting stable conditions in the economyetc.

2. Effectiveness of monetarypolicy as an instrumentofestablishing economic stability, controlling

inflationanddeflationintheeconomy.

3. Effectiveness of fiscal policy in controlling consumption, regulating production, encouraging

saving and investment and in the redistribution of income to establish stable conditions in the economy.

4. Physical policy or direct controls regulating consumption, production, foreign trade and
establishingstableconditionsintheeconomy. 12.2ConceptOfEconomicStability Promotingeconomicstabilityispartlyamatterofavoidingeconomicandfinancialcrisis.Adynamic market economy necessarily involves some degree of instability, as well as gradual structural change.Thechallengeforthepolicymakersistominimizethisinstabilitywithoutreducingtheability oftheeconomicsystemtoraiselivingstandardsthroughtheincreasingproductivity,efficiencyand
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employmentthat itgenerates. Economic stability is alsofostered by robust economic andfinancial institutionsandregulatoryframeworks. Economicstabilityimpliesavoidingfluctuationsinthelevelofeconomicactivitiesa100%stabilityis neither possible nor desirable. It implies only relative stability in the over all level of economic activities. A stabilizationpolicy is aset of measures introduced to stabilize afinancialsystem oreconomy.It can refer to correcting the normal behaviour ofthe business cycle. In this case the term generally referstodemandmanagementbymonetaryandfiscalpolicytoreducenormalfluctuationsinoutput, sometimesreferredtoaskeepingtheeconomyonanevenkeel.Thepolicychangesinthese circumstances are usually countercyclical, compensating for the predicted changes in employment andoutputtoincreaseshortrunandmediumrunwelfare. It canalso referto measurestaken to resolveaspecificeconomic crisisfor instance anexchange ratecrisisorstockmarketcrash,inordertopreventtheeconomydevelopingrecessionorinflation. The initiative is taken by the government or Central Bank or both. Depending on the goal to be achieveditinvolvessomecombinationofrestrictivefiscalmeasuresandmonetarytightening. Suchstabilizationpoliciescanbepainful,intheshortrun,fortheeconomybecauseofloweroutput and higher unemployment. Theyaredesignedto be aplatformfor successful long run growth and reform.

12.3 DifferentInstrumentsOfEconomicStability
1.MonetaryPolicy.2.FiscalPolicy&3.PhysicalpolicyorDirectControls. The Central Bank and the Government have developed these instruments to correct the discrepanciesthatoccurintheprocessofeconomicgrowth. SelfAssessmentQuestions1 1. ________meansconstantprice,overaperiodoftime 2. _____ , by regulating its credit policy, can control the credit as per the requirement of the economy. 3. Thetwoinstrumentsofmonetarypolicyare____and_____.

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12.4.MonetaryPolicy Monetarypolicyisapartoveralleconomicpolicyofacountry.Itisemployedbythegovernmentas aneffectivetooltopromoteeconomicstabilityandachievecertainpredeterminedobjectives. Meaninganddefinition: Monetary Policy deals with the total money supply and its management in an economy. It is essentiallyaprogrammeofactionundertakenbythemonetaryauthoritiesgenerallythecentralbank to control and regulate the supply of money with the public and the flow of credit with a view to achievingeconomicstabilityandcertainpredeterminedmacroeconomicgoals. Monetarypolicycanbeexplainedintwodifferentways.Inanarrowsense,itisconcernedwith administeringandcontrollingacountrysmoneysupplyincludingcurrencynotesandcoins, credit money, level of interest rates and managing the exchange rates. In a broader sense, monetary policy deals with all those monetary and nonmonetary measures and decisions thataffectthetotalmoneysupplyanditscirculationinaneconomy.Italsoincludesseveral nonmonetary measures like wages and price control, income policy, budgetary operations takenbythegovernmentwhichindirectlyinfluencethemonetarysituationsinaneconomy. Differentwritershavedefinedmonetarypolicyindifferentways.Someoftheimportantonesareas follows. 1.According to RP Kent, Monetarypolicy is the managementof theexpansion and contractionof thevolumeofmoneyincirculationfortheexplicitpurposeofattainingaspecificobjectivesuchasfull employment. 2.InthewordsofD.C.Rowan,Themonetarypolicyisdefinedasdiscretionaryactundertakenbythe authorities designed to influence the supply of money, cost of money or interest rate and the availabilityofmoney. Monetary policy basically deals with total supply of legal tender money, i.e., currency notes and coins,totalamountofcreditmoney,levelofinterestrates,exchangeratepolicyandgeneralliquidity positionofthecountry. Creditpolicywhichisdifferentfromthemonetarypolicyaffectsallocationofbankcreditaccordingto theobjectiveofmonetarypolicy.

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Thegovernmentinconsultationwiththecentralbankformulatesmonetarypolicyanditisgenerally carriedoutandimplementedbythecentralbank.Itisevolvedoveraperiodoftimeonthebasisof the experience of a nation. It is structured and operated with in the institutional framework and money market of the country. Its objectives, scope and nature of working etc is collectively conditionedbytheeconomicenvironmentandphilosophyoftime.Monetarypolicyalongwithfiscal policyanddebtmanagementlumpedtogetherformthefinancialpolicyofthecountry. Monetary policy is passive when the central bank decides to abstain deliberately from applying monetarymeasures.Itisactivewhenthecentralbankmakesuseofcertaininstrumentstoachieve the desired objectives. It may be positive or negative. It is positive when it promotes economic activitiesanditisnegativewhenitrestrictsorcurbseconomicactivities.Similarly,itisliberalwhen thereisexpansionincreditmoneyanditisrestrictivewhenitleadstocontractioninmoneysupply. Again,acheapmoneypolicymaybefollowedbycuttingdowntheinterestratesoradearmoney policybyraisingtherateofinterest. TheScopeandeffectivenessofmonetarypolicydependsonthemonetizationoftheeconomyand thedevelopmentofthemoneymarket. Parametersofmonetarypolicy: Broadly speaking there are three parameters of monetary policy of a country. It is through these parameters,themonetarypolicyhastooperate.Theyare 1.Totalmoneysupplyavailableinacountry. 2.Costofborrowingsorthelevelofinterestrates. 3.Thenatureofcreditcontrolmeasures. Allthethreeputtogetherdeterminethenatureofworkingofmonetarypolicy. 12.4.1.ObjectivesOfMonetaryPolicy Objectives of monetary policy must be regarded as a part of overall economic objectives of the government. It should be designed and directed to achieve different macro economic goals. The objectives may be manifold in relation to the general economic policy of a nation. The various objectives may be inter related, interdependentand mutually complementary toeachother. They may also be mutually inconsistent and clash with each other. Hence, very often the monetary authorities are concerned with a careful choice between alternative ends. The priorities of the
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objectives depend on the nature of economic problems, its magnitude and economic policy of a nation.Thevariousobjectivesalsochangeoveratimeperiod. Economistshaveconflictinganddivergentviewswithregardtotheobjectivesofmonetarypolicyina developedanddevelopingeconomy.Therearecertaingeneralobjectivesforwhichthereiscommon consentandcertainotherobjectivesarelaiddowntosuittothespecialconditionsofadeveloping economy. The main objective in a developed economy is to ensure economic stability and help in maintainingequilibriumindifferentsectorsoftheeconomywhereasinadevelopingeconomyithas togiveabigpushtoaslowlydevelopingeconomyandacceleratetherateofeconomicgrowth. Generalobjectivesofmonetarypolicy. 1.Neutralmoneypolicy: Prof. Wicksteed, Hayak, Robertson and others have advocated this policy. This objective was in vogueduring thedays of gold standard. According to this policy, money is only atechnical devise having no other role to play. It should be a passive factor having only one function, namely to facilitate exchange. It shouldnot inject any disturbances. It should be neutral in its effects on prices, income, output, and employment. They considered that changes in total money supply aretherootcauseforallkindsofeconomicfluctuationsandassuchifmoneysupplyisstabilizedand moneybecomesneutral,thepricelevelwillvaryinverselywiththeproductivepoweroftheeconomy. Ifproductivityincreases,costperunitofoutputdeclinesandpricesfallandviceversa.Accordingto this policy, money supply is not rigidly fixed. It will change whenever there are changes in productivity, population, improvements in technology etc to neutralize fundamental changes in the economy. Under these conditions, increase or decrease in money supply is allowed to result in eitherfallorraiseingeneralpricelevel.Inadynamiceconomy,thispolicycannotbecontinuedand itishighlyimpracticableinthepresentdayeconomy. 2.Pricestability: With the suspension of the gold standard, maintenance of domestic price level has become an importantaimofmonetarypolicyallovertheworld.Thebitterexperienceof1920sand1930shas madeallmostalleconomiestogoforpricestability.Bothinflationanddeflationaredangerousand detrimental to smooth economic growth. They distort and disturb the working of the economic system and create chaos. Both of them are bad as they bring unnecessary loss to some groups where as undue advantage to some others. They have potential power to create economic
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inequality, political upheavals and social unrest in any economy. In view of this, price stability is consideredasoneofthemainobjectivesofmonetarypolicyinrecentyears.Itistoberemembered that price stability does not mean that prices of all commodities are kept constant or fixed over a periodoftime.Itreferstotheabsenceofsharpvariationsorfluctuationsintheaverageprice level in the country. A hundred percent price stability is neither possible nor desirable in any economy. It simply implies relative price stability. A policy of price stability checks cyclical fluctuations and smoothen production and distribution, keeps the value of money stable, preventartificialscarcityorprosperity,makeseconomiccalculationspossible,introducesan elementofcertainty,eliminatesocioeconomicdisturbances,ensureequitabledistributionof income and wealth, secure social justice and promote economic welfare. On account of all these benefits, monetary authoritieshave to take concrete steps to check price oscillations. Price stability is considered as one of the prerequisite condition for economic development and it contributes positively to the attainment of a steady rateof growth inan economy. This is because price stability will build up public morale and instill confidence in the minds of people, boost up business activity, expand various kinds ofeconomic activities and ensuredistributive justice in the country.ProfBasurightlyobserves,Amonetarypolicywhichcanmaintainareasonabledegreeof pricestabilityandkeepemploymentreasonablyfull,setsthestageofeconomicdevelopment. 3.Exchangeratestability: Maintenanceofstableorfixedexchangeratewasoneofthemajorobjectsofmonetarypolicyfora long time under the gold standard. The stability of national output and internal price level was consideredsecondaryandsubservienttotheformer.Itwasthroughfreeandautomaticimportsand exports of gold that the country was able to remove the disequilibrium in thebalance of payments andensurestabilityofexchangerateswithothercountries.Thegovernmentfollowedthepolicyof expanding currency and credit with the inflow of gold and contracting currency and credit with the outflowofgold.InviewofsuspensionofgoldstandardandIMFmechanism,thisobjecthaslostits significance. However, in order to have smooth and unhindered international trade and free flow of foreign capital in to a country, it becomes imperative for a county to maintain exchangeratestability.Changesindomesticpriceswouldaffectexchangeratesandassuchthere is great need for stabilizing both internal price level and exchange rates. Frequent changes in exchangerateswouldadverselyaffectimports,exports,inflowofforeigncapitaletc.Hence,itshould becontrolledproperly.
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4.Controloftradecycles: Operation oftrade cycles has become very common in modern economies.A very highdegreeof fluctuations in over all economic activities is detrimental to the smooth growth of any economy. Economicinstabilityintheformofinflation,deflationorstagflationetcwouldserveasgreatobstacles to the normalfunctioning ofan economy. Basically, changes in total supply of money are the root causeforbusinesscyclesanditsdampeningeffectsontheentireeconomy.Hence,ithasbecome one of the major objectives of monetary authorities to control the operation of trade cycles andensureeconomicstabilitybyregulatingtotalmoneysupplyeffectively.Duringtheperiod of inflation, a policy of contraction in money supply and during the period of deflation, a policy of expansioninmoneysupplyhastobeadopted.Thiswouldcreatethenecessaryeconomicstability forrapideconomicdevelopment. 5.Fullemployment: Inrecentyearsithasbecomeanothermajorgoalofmonetarypolicyallovertheworldespeciallywith thepublicationofgeneraltheorybyLordKeynes.ManywellknowneconomistslikeCrowther,Halm. GardnerAckley,William,BeveridgeandLordKeyneshavestronglyadvocatedthisobjectiveinthe contextofpresentdaysituationsinmostofthecountries.Advancedcountriesnormallyworkatnear fullemploymentconditions.Theirmajorproblemistomaintainthishighlevelofemploymentsituation through various economic polices. This object has become much more important and crucial in developing countries as there is unemployment and under employment of most of the resources. Deliberate efforts are to be made by the monetary authorities to ensure adequate supply of financialresourcestoexploitandutilizeresourcesinthebestpossiblemannersoastoraise thelevelofaggregateeffectivedemandintheeconomy. Itshouldalsohelptomaintainbalance betweenaggregatesavingsandaggregateinvestments.Thiswouldensureoptimumutilizationofall kindsofresources,highernationaloutput,incomeandhigherlivingstandardstothecommonman. 6.Equilibriuminthebalanceofpayments: Thisobjectivehasassumedgreaterimportanceinthecontextofexpandinginternationaltradeand globalization. To day most of the countries of the world are experiencing adverse balance of paymentsonaccountofvariousreasons.Itisasituationwhereintheimportpaymentsareinexcess of export earnings. Most of the countries which have embarked on the road to economic developmentcannotdoawaywithimportsonalargescale.Importsofseveralitemshavebecome

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indispensableandwithouttheseimportstheirdevelopmentprocesswillbehalted.Hence,monetary authoritieshavetotakeappropriatemonetarymeasureslikedeflation,exchangedepreciation, devaluation, exchange control, current account and capital account convertibility, regulate creditfacilitiesandinterestratestructuresandexchangeratesetc.Inordertoachieveahigher rate of economic growth, balance of payments equilibrium is very much required and as such monetaryauthoritieshavetotakesuitableactioninthisdirection. 7.Rapideconomicgrowth: This is comparatively a recent objective of monetary policy. Achieving a higher rate of per capita output and income over a long period of time has become one of the supreme goals of monetary policy in recent years. A higher rate of economic growth would ensure full employment condition, higher output, income and better living standards to the people. Consequently, monetary authorities have to take the necessary steps to raise the productive capacity of the economy,increasethelevelofeffectivedemandforvariouskindsofgoodsandservicesandensure balancebetweendemandforandsupplyofgoodsandservicesintheeconomy.Alsotheyshould takemeasurestoincreasetherateofsavings,capitalformation,stepupthevolumeofinvestment, direct credit money into desired directions, regulate interest rate structure, minimize economic and businessfluctuationsbybalancingdemandformoneyandsupplyofmoney,ensurepriceandoverall economicstability,betterandfullutilizationofresources,removeimperfectionsinmoneyandcapital markets,maintainexchangeratestability,allowtheinflowofforeigncapitalintothecountry,maintain the growth of money supply in consistent with the rate of growth of output minimize adversity in balance ofpayments condition, etc. Dependingupon the conditions of theeconomy money supply hastobechangedfromtimetotime.Aflexiblepolicyofmonetaryexpansionorcontractionhastobe adoptedtomeetaparticularsituation.Thus,agrowthfriendlymonetarypolicyhastobepursuedby monetaryauthoritiesinordertostimulateeconomicgrowth. It is to be noted that the abovementioned objectives are inter related, inter dependent and inter connected with each other. Each one of the objectives would affect the other and in its turn is influenced by the others. Many objectives would come in clash with others under certain circumstances. A proper balance between different objectives becomes imperative. Monetary authoritieshavetodeterminetheprioritiesdependingupontheeconomicenvironmentinacountry. Thus,thereisgreatneedforcompromisebetweendifferentobjectives

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Objectivesofmonetarypolicyindevelopingcountries: Asthedevelopmentproblemsofdevelopingcountriesaredifferentfromthatofdevelopedcountries, the objectivesof monetarypolicyalso changes.Thefollowing objectives maybe considered in the contextofdevelopingcountries. 1.Developmentrole: It has to promote economic development by creating, mobilizing and providing adequate credit to different sectors of the economy. Supply of sufficient financial resources, its proper direction, canalizationandutilization,controlofinflationanddeflationetcwouldcreateproperbackgroundfor layingasolidfoundationforrapideconomicdevelopment. 2.Effectivecentralbanking: Inordertoachievevariousobjectivesofmonetarypolicyandtomeettheevergrowingdevelopment requirements of the economy, the central bank of the country has to operate effectively. It has to control the volume of credit money and its distribution through the use of various quantitative and qualitativecreditinstruments.Centralbankofthecountryshouldactasaneffectiveleadertocontrol theactivitiesofallotherfinancialinstitutionsinthecountry.Itshouldcommandtherespectofother institutions. 3.Inducementtosavings: It has to encourage the saving habits of the common man by providing all kinds of monetary incentives. It has to take the necessary steps to expand the banking facilities in the country and mobilizesavingsmadebythem.Specialstepsaretobetakentomobilizeruralsmallsavings. 4.Investmentofsavings: Itshouldhelpinconvertingsavingsintoproductiveinvestments.Forthispurpose,ithastocreatean institutionalbaseandinvestmentclimateinthecountry.Peopleshouldhavevarietyofopportunities toinvesttheirhardearnedmoneyandearnadequateretunesonthem. 5.Developingbankinghabits: Monetary authorities have to take effective and imaginary steps to popularize the use of various creditinstrumentsbythecommonman.Bankingtransactionsshouldbecomethepartoftheirdayto daylife.

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6.Magnetizationoftheeconomy: Themonetaryauthoritieshavetotakedifferentmeasurestoconvertnonmonetizedsectororbarter sectorintomonetizedsectorandmakepeopleusecreditmoneyextensivelyintheirdaytodaylife. Increase in total money supply should be in accordance with the degree of monetization of the economy. 7.Monetaryequilibrium: Itistheresponsibilityofthemonetaryauthoritiestomaintainaproperbalancebetweendemandfor moneyandsupplyofmoneyandensureadequateliquiditypositionintheeconomysothatneither therewillbeexcesssupplyofmoneynorshortageinthecirculationofmoney. 8.Maintainingequilibriuminthebalanceofpayments: It is the job of the monetary authorities to employ suitable monetary measures to set right disequilibriuminthebalanceofpaymentsofacountry. 10.Creationandexpansionoffinancialinstitutions: Monetaryauthoritiesofthecountryhavetotakeeffectivestepstoimprovetheexistingcurrencyand credit system. They should help in developing banking industry, credit institutions, cooperative societies,developmentbanksandothertypesoffinancialinstitutions,tomobilizemoresavingsand directthemtoproductiveactivities. 11.Integrationoforganizedandunorganizedmoneymarkets: The money markets are under developed, undeveloped, highly unorganized and they are not functioningonanywelllaiddownprinciples.Infact,thereisnoproperintegrationbetweenorganized and unorganized money markets. This has come in the way of welldeveloped money markets in thesecountries.Hence,moneymarketsaretobebroughtunderthepurviewofthecentralbankof thecountry. 12.Integratedinterestratestructure: The monetary authorities have to minimize the existence of different interest rates in different segmentsofthemoneymarketandensureanintegratedinterestratestructure.

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13.Debtmanagement: Monetaryauthoritieshavetodecidethetotalvolumeofinternalaswellasexternalborrowings,timing of the issueof bonds, stabilizing their prices, the interest rates to be paidfor them, nature ofdebt servicing,timeandmethodsofdebtredemption,thenumberofinstallments,timeofrepaymentetc. Theprimaryaimofthedebtmanagementpolicyistocreateconditionsinwhichpublicborrowingis increasedfromyeartoyearonabigscalewithoutgivinganyjolttothesystemandthismustbeat cheap rates to keep the burden of the debt as low as possible. Thus, debt management of the countryistobesuccessfullyorganizedbythemonetaryauthorities. 14.Longtermloanforindustrialdevelopment: Themonetarypolicyshouldbeframedinsuchawayastopromoterapidindustrialdevelopmentina countrybyprovidingadequatefinanceforthem. 15.Reformingruralcreditsystem: The existing rural credit system is defective and as such it has to be reformed to assist the rural masses. 16.Tocreateabroadandcontinuousmarketforgovernmentsecurities: Itistheresponsibilityofthemonetaryauthoritiesofthecountrytodevelopawellorganizedsecurities marketsothatfundsareeasilyavailablefortheneedypeople. Thus,theobjectivesofmonetarypolicyaremanifoldinnatureindevelopingcountriesandaproper balancebetweenthemisrequiredverymuchtoachievedesiredgoalsofthegovernment. Monetarypolicyandeconomicdevelopment: Monetary policy has to play a major and constructive role in developing countries in order to accelerateandpromoteeconomicdevelopment.Therateofeconomicgrowthofacountrydepends onthevolumeofinvestment.Highertheinvestmenthigherwouldthegrowthrateandviceversa.In ordertoraisethelevelofinvestment,themonetaryauthorizeshavetotakeanumberofstepslike givingincentivestosavings,increasetherateofcapitalformation,mobilizemorefunds,bothinurban and rural areas, set up various financial institutions, channalise them in to productive areas, offer reasonableinterestrates,etc.Ithastofollowaflexibleandelasticmonetarypolicytosuitparticular conditions.Thevariousobjectiveshavealreadyhighlightedthesignificanceofeachoneofthemand howtheycontributeforeconomicdevelopmentofacountry.Allkindsofmonetaryinstrumentsareto
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beusedintherightproportionsoastofulfillthedesiredgoals.Anappropriatemonetarypolicywill certainlyhelp inachieving full employment condition andensure rapid economic growth. Hence,a growthpromotingmonetarypolicyhastobeformulatedinthecontextofadevelopingeconomy. 12.4.2.InstrumentsOfMonetaryPolicy Broadlyspeakingtherearetwoinstrumentsthroughwhichmonetarypolicyoperates.Theyarealso calledtechniquesofcreditcontrol. I.Quantitativetechniquesofcreditcontrol: Theyincludebankratepolicy,openmarketoperationsandvariablereserveratio. II.Qualitativetechniquesofcreditcontrols: They include change in margin requirements, rationing of credit, regulation of consumers credit, moralsuasion,issueofdirectives,directactionandpublicityetc. 1.Quantitativetechniquesofcreditcontrol: Theoperationofthequantitativetechniquesorgeneralmethodswillhaveageneralimpactonthe entireeconomyregulatingthesupplyofcreditmadeavailabletodifferentactivities. TheBankRateistherateatwhichthecentralbankofacountryiswillingtodiscountfirstclassbills. IftheBankRateisraised,themarketratesandotherlendingratesofthemoneymarketalsogoup. Conversely,thelendingratesgodownwhenthecentralbanklowersitsbankrate.Thesechanges affect the supply and demand for money. Borrowing is discouraged when the rates go up and encouragedwhentheygodown. Theflowofforeignshorttermcapitalalsoisaffected.Thereisaninflowofforeignfundswhenthe ratesareraisedandanoutflowwhentheyarereduced. Internalpriceleveltendstofallwiththecontractionofcredit.Andittendstorisewithitsexpansion. Business activity, both industrial and commercial, is stimulated when the rates of interest are low, anddiscouragedwhentheyarehigh. Adversebalanceofpaymentsinforeigntradecanbecorrectedthroughloweringofcostsandprices. Thusbankratethroughitsinfluenceonsupplyofanddemandformoneyhelpsintheestablishment ofstabilityintheeconomy.

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OpenMarketOperationsrefertothepurchaseorsaleofgovernmentsecurities,shorttermaswell as longterm, by the central bank. When the central bank sells securities cash balances with the commercialbanksdecline,theyarecompelledtoreducetheirlending.Thuscreditcontracts.Onthe otherhandpurchasesofsecuritiesenablecommercialbankstoexpandcredit. Thismethodissometimesadoptedtomakethebankrateeffective. VaryingReserveRatioVariationsofreserverequirementsaffecttheliquiditypositionofthebanks and hence their ability to lend. By raising the reserve requirements inflationary trend can be kept under control. The lowering of the reserve ratio makes more cash available with the banks. The Reserve Bank of India has been empowered to vary the Cash reserve ratio from the minimum requirementof3 % to15% of the aggregate liabilities. Cash Reserves maintained by commercial banks is called statutory reserve and the reserve over and above the statutory reserves is called excessreserve. QualitativeTechniquesofCreditControl Changes in the margin requirements, direct action, moral suasion, rationing of credit, issue of directives, and regulation of consumer credit are some of the qualitative techniques which are in practicegenerally. While lending money against securities banks keep a certain margin. Central Bank can issue directivestocommercialbankstomaintainhighermarginswhenitwantstocurtailcreditandlower themarginrequirementstoexpandcredit. Direct action implies a coercive measure like, central bank refusing to provide the benefit of rediscountingofbillsforsuchbankswhosecreditpolicyisnotinaccordancewiththewishesofthe centralbank. The central bank on the other may follow a mild policy of moral suasion where it requests and persuadesamemberbanktorefrainfromlendingforspeculativeornonessentialactivities. The Credit is rationedby limiting the amountavailable to each applicant. Central bank may also restrictitsdiscountstobillsmaturingaftershortperiods. Central bank, in the form of directives to commercial banks can see that the available funds are utilizedinapropermanner.

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Regulation of consumer credit can have a direct impact on the demand for various consumer durables. ThusCrowtherconcludesthatthepolicy0fthecentralbankusingitsfreediscretionwithinlimitsthat arenormallyverybroadcancontrolthevolumeofmoneyandcredit,initsownfieldthecentralbank isclearlyadictator. 12.4.3.MonetaryPolicyToControlInflation Thebestremedyforfightinginflationistoreducetheaggregatespending.Monetarypolicycanhelp in reducing the pressure on demand. During inflation, the central bank can raise the cost of borrowing and reduce the credit creation capacity of the commercial banks. This makes banks to becomemorecautiousintheirlendingpolicies.Theriseinthebankrate,raisingtheinterestrates not only makes borrowing costly but also will have an adverse psychological effect on business confidence.Ariseintherateofinterestmayalsoencouragesavinganddiscouragespending.The central bank can reduce the credit creation capacity of the commercial banks through the open marketsaleofsecuritiesandraisingthecashreserveratiotobemaintainedwiththecentralbank. Some of the selective credit control measures can also be adopted, like varying margin requirements,moralsuasion,directactionetc.toregulatecredit. Monetarypolicyhasitsownlimitationsincontrollinginflation. An increase in the bank rate may be ineffective if commercial banks do not follow the rise in the bankratebyraisingtheirowninterestrates.Evenifthereisariseintheinterestrateitmaynotbe abletocurbspendingsignificantly.Fortheopenmarketoperationstobeeffectivethereshouldbea well developed and closely knit money market. If the commercial banks are in the habit of maintainingexcessreserveswiththecentralbankrisingofthestatutoryreserveratiowillnothave anyimpactontheirlending. Amajordifficultyarisesbecauseofthedichotomyinthemoneymarket.InourcountrytheReserve Bankcancontrolonlytheorganizedsectorwhichconstitutesonlyaverysmallportionofthemoney market.Indigenousbankersandmoneylenderswhodobulkoflendinglieoutsidethecontrolofthe ReserveBank. Thuseffectivenessofmonetarypolicyincontrollinginflationparticularlyinadevelopingeconomyis verymuchlimited.

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12.4.4.MonetaryPolicyToCheckDeflation Deflationistheoppositeofinflation.Itisessentiallyamatteroffallingprices.Deflationariseswhen thetotalexpenditureofthecommunityisnotequaltothevalueoftheoutputattheexistingprices. Consequently the value of money goes up and prices fall. Deflation has an adverse effect on the levelofproduction,businessactivityandemployment.Italsoadverselyaffectsdistributionofwealth and income. In this sense, deflation is worsethan inflation. Both inflationanddeflation are socially bad,butinflationmaybeconsideredtobethelesserofthetwoevils. MonetarymeasureslikeBankRate,OpenMarketOperations,VariableReserveRatioandselective techniques of credit control may be used to expand credit, stimulate bank advances for various schemes.Whenthebusinesscommunityisinthegripofpessimism,substantialreductionininterest ratesdonotinducethemtoventureintonewinvestmentsandexpandproduction.Thehorsemaybe taken to water, but it may refuse to drink. The monetary authority can only encourage business enterprises.Thelowerinterestratemayonlyimprovethestateofliquidityintheeconomy. Hence, Modern economists do not give much importance to monetary policy as a tool to keep economicactivityinpropertrim. SelfAssessmentQuestions2 1. Theoldestmethodofcontrollingcreditis____ 2. Cashreservesmaintainedbycommercialbankiscalled_____________. 3. ReserveoverandabovetheStatutoryReserveiscalled_______. 4. ________arealsoknownasselectiveinstrumentofcreditcontrol.

12.5. FiscalPolicy Fiscalpolicyisanimportantpartoftheoveralleconomicpolicyofanation.Itisbeingincreasingly usedinmoderntimestoachieveeconomicstabilityandgrowththroughouttheworld.LordKeynes forthefirsttimeemphasizedthesignificanceoffiscalpolicyasaninstrumentofeconomiccontrol.It exertsdeepimpactonthelevelofeconomicactivityofanation.

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Meaning The term fisc in English language means treasury, and as such, policy related to treasury or governmentexchequerisknownasfiscalpolicy.Fiscalpolicyisapackageofeconomicmeasuresof thegovernmentregardingitspublicexpenditure,publicrevenue,publicdebtorpublicborrowings.It concerns itself with the aggregate effects of government expenditure and taxation on income, productionandemployment.Inshortitreferstothebudgetarypolicyofthegovernment. Definitions 1.InthewordsofUrsulaHicks,Fiscalpolicyisconcernedwiththemannerinwhichallthedifferent elementsofpublicfinance,whilestillprimarilyconcernedwithcarryingouttheirownduties[asthe first duty ofa tax is to raise revenue] may collectively be geared toforward the aims of economic policy. 2. Gardner Ackley points out, Fiscal policy involves alterations in government expenditures for goodsandservicesortheleveloftaxrates.Unlikemonetarypolicy,thesemeasuresinvolvedirect governmentinterferenceintothemarketforgoodsandservices[incaseofpublicexpenditure]and directimpactonprivatedemand[incaseoftaxes].

12.5.1.InstrumentsOfFiscalPolicy 1PublicRevenue: Itreferstotheincomeorreceiptsofpublicauthorities.Itisclassifiedintotwo partsTaxrevenueandnontaxrevenue.Taxesarethemainsourceofrevenuetoagovernment. Therearetwotypesoftaxes.Theyaredirecttaxeslikepersonalandcorporateincometax,property taxandexpendituretaxetcandindirecttaxeslikecustomsduties,exciseduties,salestaxnowcalled VAT etc. Administrative revenues are the biproducts of administrate functions of the government. They include Fees, license fees, price of public goods and services, fines, escheats, special assessmentetc. 2. Public expenditure policy: It refers to the expenditure incurred by the public authorities like central, state and localgovernments. It is of two kinds,developmentor planexpenditure andnon development or nonplan expenditure. Plan expenditure include incomegenerating projects like development of basic industries, generation of electricity, development of transport and

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communications, construction of dams etc Nonplan expenditure include defense expenditure, subsidies,interestpaymentsanddebtservicingchangesetc. 3. Public debt or public borrowing policy: All loans taken by the government constitutes public debt.Itreferstotheborrowingsmadebythegovernmenttomeettheeverrisingexpenditure.Itisof twotypes,internalborrowingsandexternalborrowings. 4. Deficit financing: It is an extraordinary technique of financing the deficits in the budgets. It implies printing of fresh and new currency notes by the government by running down the cash balanceswiththecentralbank.Theamountofnewmoneyprintedbythegovernmentdependson theabsorptioncapacityoftheeconomy. 5. Built in stabilizers or automatic stabilizers: [BIS] The automatic or built in stabilizers imply, automatic changes in tax collections and transfer payments or public expenditure programmes so that it may reduce destabilizing effect on aggregate effective demand. When income expands, automaticincreaseintaxesorreductionintransferpaymentsorgovernmentexpenditureswilltendto moderatetheriseinincome.Onthecontrary,whentheincomedeclines,taxfallsautomaticallyand transfersandgovernmentexpenditurewillriseandthusbuiltinstabiliserscushionsthefallinincome. Fiscaltools: Subsidies,developmentrebates,taxreliefs,taxconcessions,taxexemptions,andtax holidays, freight concessions, relief expenditures, debt reliefs, transfer payments, public works programmesetc.aresomeofthemaintoolsofthefiscalpolicy. Keynesinsistedthatpublicfinanceshouldbeadjustedtothechangingconditionsoftheeconomy,to fightinflationarypressuresanddeflationarytendencies.Theroleoffiscalpolicycanbecomparedto thedrivingofacar.Whiledrivingupagradient(i.e.,steppingupproductionandproductivity),whatis needed is an increase in power (promotion of higher savings and investment through fiscal measures).Ontheotherhand,whenitmovesagainstthenationalinterest,itisnecessarytocontrol thesupplyofpower(tocombatinflationaryandforeignexchangecrisisthroughhighertaxation)and alsotoapplybrakesjudiciouslytoensurethatthevehicledoesnotslipoutofcontrolbutkeepson movingallthesame.Thenationalexchequershouldseethatthebrakesarenotpressedsomuchas tobringthevehicletoastop. Inshort,itisthefunctionofpublicfinancetomakeeconomygrowmaintainitingoodhealthandto protectitfrominternalandexternaldangers.

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12.5.2 ObjectivesOfFiscalPolicy 1Tohelpinoptimumallocationofscarceresourcesanditsmaximumutilization: Idlearetobemobilizedandallocatedtodifferentsectorsoftheeconomyinaccordancewithnational priorities.Hence,suitablefiscalpolicyistobeformulatedinthisdirection. 2.Toacceleratetherateofcapitalformation. Fiscalpolicyshouldhelpinmobilizingthesmallsavingsbothinruralandurbanareassoastoraise thelevelofcapitalformationinthecountry. 3.Toencourageinvestment: Fiscal policy should direct investment in the desired channels both in the public and in theprivate sectorsbyprovidingsuitableincentives. 4.Toensurepricestability: Appropriatefiscalpolicyhastobeformulatedinordertocontrolthedemonofinflation,deflationand stagflationandensureareasonabledegreeofpricestabilityinthecountry. 5.Tocontroltheoperationofbusinesscycles: An appropriate fiscal policy has to be formulated so as to counteract the adverse and dampening effects of trade cycles, to minimize business fluctuations and achieve a reasonable degree of economicstabilityintheeconomy. 6.Toensurefullemploymentcondition: Fiscal policy should help in exploiting all kinds of resources available in the country in the best possiblemannerandensurefullemploymentconditionintheeconomy. 7.Toacceleratetherateofeconomicgrowth. Themainobjectiveofthefiscalpolicyistostimulateandacceleratetherateofeconomicgrowthin the country. All instrumentsoffiscalpolicyhavetobeemployed inorder to give a big push to the processofdevelopmentinthecountry. 8Toensureequitabledistributionofincomeandwealth: Inthecourseofeconomicdevelopment,itisquitepossiblethatmonopolyhouseswouldgrowand income and wealth gets concentrated in the hands of only a few powerful and influential persons.
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Hence,suitablefiscalpolicyhastobeadoptedtoreduceincomedisparitiesandensuredistributive justicetothecommonman. 9.Toreduceandminimizeregionalandsectoralimbalances: In most of the countries there is wide spread disparities in the levels of development in different regions of the country. Suitable fiscal policy has to be designed to avoid, minimize and reduce regionalandsectoralimbalancesandensuresbalancedgrowthinthecountry. 10.Tomobilizerealandfinancialresourcesforpublicsectorinlargerquantity Public sector has assumed greater significance in planned economic development of a country in recentyears.Hence,anappropriatefiscalpolicyistobedesignedtomobilizeallkindsofrealand financialresourcesforthesuccessfulworkingofthepublicsector. Objectivesindevelopingcountries The development problems of developing countries are totally different from that of developed countries and as such the objectives of fiscal policy also changes in such economies. These objectivesarelistedbelow. 1.Helptobreaktheviciouscircleofpoverty: Mostofthedevelopingcountriesarecaughtinthegripofviciouscircleofpovertyforthepastseveral decadesandcenturies.Theyarestrugglingveryhardtocomeoutofthisviciouscircleandcreate the background for normal economic growth. It is possible only through increasing the rate of investments in all sectors simultaneously. Hence, suitable fiscal policy has to be formulated to mobilizefinancialresourcesrequiredforheavydosesofinvestments. 2.Helptoformulatearationalconsumptionpolicy: InordertoreduceMPCandincreaseMPS,itbecomesinevitabletopursuearationalconsumption policy, which helps in curbing conspicuous consumption, and release the resources for saving purposes. 3.Helptoraisetherateofsavings: Fiscalpolicyshouldhelpinmobilizingbothvoluntaryandforcedsavings.Variouskindsofincentives maybeofferedtoencouragesavings. 4.Helptoincreasethevolumeofinvestment:
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Economicdevelopmentdirectlydependsontheamountofmoneyinvestedindifferentsectorsofthe economy. Fiscal policy shouldhelp in converting the savings madeby the people into investments andcreatetherequiredeconomicenvironmenttopromoteinvestmentactivityinthecountry. 5.Helptodiversifytheflowofresources: The existing scarce resources are to be diverted from unproductive and speculative areas and directed towards the most productive uses and socially desirable channels so as to maximize net socialgainstothecommonman. 6.Helptoraiselivingstandards: Oneofthemaingrowthparametersisthatthecommonmaninthecountryshouldbeinapositionto enjoythebasicnecessariesoflifeinadequatequantity.Hence,thegovernmenthastotakeconcrete measurestoensurethesupplyofsocialgoodsonalargescale.Inordertoachievethisobjective suitablefiscalpolicyhastobeformulated.Forexample,throughpublicdistributionsystem,minimum quantitiesofcertainitemsaretobesuppliedatsubsidizedrates. 7.Helptoachievefullemploymentandstimulategrowthrates: The supreme goal of developing countries is toachieve higher rates ofeconomicgrowth. Suitable fiscalpolicyhastobeformulatedtoexploitallkindsofresourcessothattheeconomycanreachthe stage of full employment condition. Full employment condition results in optimum national output, higheraggregatedemand,andincome. 8.Helptoreduceeconomicinequalities: Througharationalfiscalpolicy,thegovernmenthastotakeadequatemeasurestocontrolthegrowth ofmonopolyhouses,minimizeeconomicinequalitiesandensuredistributivejusticetoall. 9.Helptocontrolinflationanddeflation: Rapideconomicgrowthrequirespricestability.Itisthedutyofthegovernmenttoadoptallkindsof measures through suitable fiscal instruments to control inflation, deflation and stagflation so as to achieve a reasonable degree of price stability. It should also help in mobilizing excesspurchasing powerinthehandsofpeoplethroughsuitabletaxationpolicy. 10Helptocreatemorejobopportunities:

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In most of the developing nations, there is an army of unemployed people. The services of these people are to be utilized by creating more productive jobs on a largescale to absorb them. The governmentthroughappropriatefiscalpolicyhastomobilizehugefundsandinvestthemindifferent sectors of the economy. Higher investment results in higher economic growth rate and creation of moreemploymentopportunities. It is quite clear that the objectives of fiscal policy are different for developed and developing countries.Itistobenotedthatthevariousobjectiveslistedabovearemutuallyinterrelatedandinter connected to each other. Some of the objectives are common to both developed and developing countries. In some cases, one objective may come in clash with the other. For example, growth objectivemaycomeinclashwithcontrollinginflation.Again,withrapiddevelopment,theremaybe growth of monopolies andconcentration of income and wealthand this will come in clash withthe objectiveofminimizingeconomicinequalitiesinthecountry.Hence,thegovernmenthastomaintain harmonyandbalancebetweendifferentobjectivesanddeterminetheprioritiesfromtimetotimeto meetthechangingrequirementoftheeconomy Roleoffiscalpolicyintheeconomicdevelopment: Inordertoachievetheabovelistedobjectives,fiscalpolicyhastoplayapositiveandconstructive rolebothindevelopedanddevelopingnations.Thespecificroletobeplayedbyfiscalpolicycanbe discussedasfollows. 1.Toactasoptimumallocatorofresources. Asmostoftheresourcesarescarceintheirsupply,carefulplanningisneededinitsallocationsoas toachievethesettargets.Rationalallocationwouldensurefulfillmentofvariousobjectives. 2.Toactasasaver. a. ItshouldfollowarationalconsumptionpolicywhichreducestheMPCandraisestheMPS. b. Taxationpolicyhastobemodifiedtoraisetheratesofoldtaxes,introducenewandadditional taxes,andextendthetaxnet. c. Profitearningcapacityofpublicsectorunitsaretoberaisesubstantiallytomopupfinancial resources. d. Thegovernmentshouldborrowmoremoneybothwithinthecountryandoutsidethecountry.

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e. Higherratesofinterestsaretobeofferedforgovernmentbondsandsecurities. f. Introductionandpopularizationofsmallsavingsschemes g. IntroductionofvariouskindsofInsuranceschemes. h. Enlargingbankingfacilitiestothenookandcornerofthecountryandadoptingarationalcredit policy. i. Developmentandpromotionofprivatefinancialinstitutions. j. Mobilizationofhoardedwealthinthecountrythroughimaginativeschemes. k. Goingformoderatedosesofdeficitfinancing l. Effectiveexerciseofvariouskindsofphysicalcontrolmeasuressoastoreleasemoreresources fordevelopmentpurposesetc. 3.Toactasaninvestor. Meremobilizationoffinancialresourcesisnotanendinitself.Itshouldresultinthecreationofreal resources which are more important in accelerating the growth process. Rapid economic growth depends on the volume of investment. Hence, fiscal policy has to ensure higher volume of investmentinbothpublicandprivatesectors.Inthepublicsectorthegovernmenthastoincreaseits investment so as to build up the required infrastructure in the country on the principle of social marginal productivity. This would automatically stimulate investments in private sectors. In its qualitativeaspect,itshouldaimatchangingthecompositionandflowofinvestmentsinthecountry. It should discourage the flow of investments in to unproductive, nonessential and speculative activities in the private sector and help in diverting these scarce resources in to highly productive areas 4.Toactaspricestabilizer Price stability is of paramount importance in an economy. Extreme levels of both inflation and defilation would disrupt and disturb the normal and regular working of an economic system. This wouldcomeinthewayofstableandpersistentgrowth.Hence,allmeasuresaretobetakentocheck thesetwodangeroussituationssoastocreatethenecessarycongenialatmospheretopreparethe backgroundforrapideconomicgrowth. 5.Toactasaneconomicstabilizer.
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Pricestabilitywouldcreatethenecessarybackgroundforoveralleconomicstability.Upswingsand downswings in the level of economic activities are to be avoided. If an economy is subject to frequentfluctuationsintheformoftradecycles,certainly,itwouldundermineanddisturbthegrowth process.Instabilitywouldcomeinthewayofpersistentandconsistentgrowthinacountry.Hence, alloutmeasuresaretotakentoensureeconomicstability. 6.Toactasanemploymentgenerator. Fiscalpolicyshouldhelpinmobilizingmorefinancialresources,convertthemintoinvestmentand createmoreemploymentopportunitiestoabsorbthehugeunemployedmanpower. 7.Toactasbalancer. Theremustbeproperbalancebetweenaggregatesavingsandaggregateinvestments,demandand supply,income,outputandexpenditure,economicoverheadcapitalandsocialoverheadcapitaletc. Anysortofimbalancewouldresultineithersurplusesorscarcityindifferentsectorsoftheeconomy leadingtofastgrowthinsomesectorsfollowedbylaggingofsomeothersectorsthus,disturbingthe processofsmootheconomicgrowth. 8.Toactasgrowthpromoter. The basic objective of any economic policy is to ensure higher economic growth rates. This is possible when there is higher national savings, investment, production, employment and income. Hence, fiscal policy is to be designed in such a manner so as to promote higher growth in an economy. 9.Toactasanincomeredistributor. Fiscal policy has to minimize economic inequalities and ensure distributive justice in an economy. Thisispossiblewhenarationaltaxationandpublicexpenditurepolicyisadopted.Moremoneyisto be collectedfrom richer sectionsof thesociety through various imaginative taxation policies anda largeramountofmoneyistobespentinfavorofpoorersectionsofthesociety.Thus,inequalityisto bereducedtotheminimum. 10.Toactasstimulatoroflivingstandardsofpeople. Thefinalobjectiveistoraisetheleveloflivingstandardsofthepeople.Thisispossiblewhenthere is higher output, income and employment leading to higher purchasing power in the hands of

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common man. Hence,fiscal policy shouldhelp in creating more wealth inaneconomy. If thereis economicprosperity,thenitispossibletohaveasatisfactory,contentedandpeacefullife. Thus,fiscalpolicyhastoplayamajorroleinpromotingeconomicgrowthinacountry.

12.5.3.FiscalPolicy ToControlInflation
Inflationiscausedeitherbyanincreaseindemandorincreaseincosts.Ariseinpricesgenerally givesrisetodemandforriseinwagesandifthesedemandsaremet,theriseinwagescausescosts and prices to rise further, thus worsening the inflationary situation. Taxation as an antiinflationary measure should be used carefully choosing different types of taxes. Direct taxes like income tax, expendituretax,andexcessprofittaxetc.,takeawayfromthepublicinaveryprogressivemannera partofthepurchasingpower.Thesewillhavediscouragingeffectonconsumption.Indirecttaxes carefullychosenonafewcommoditiesmaysuppressthedemandforsuchcommoditiesandthereby reducetheinflationarypressuretosomeextent. Allinessentialandunproductiveexpensesofthegovernmentshouldbecutdown.Butasmostofthe publicexpenditureisfortheplannedeconomicdevelopmentandforthewellbeingofthepeoplethe scopeforreducingpublicexpendituretodampentheinflationarypressureisverymuchlimited. Publicborrowingparticularlyfromthenonbankinglenderswillhavedisinflationaryeffectbyreducing theircashreservesandtherebykeepingdownthedemandforgoodsandservices. If the government succeeds in raising revenue and reducing public expenditure, it will create a budgetsurplus.Ifthegovernmentusesthissurplustobuyoffthegovernmentsecuritiesheldbythe general public or the banking system there would be an expansion in the cash reserves with the public and the credit creation capacity of the commercial banks offsetting the favourable anti inflationaryeffectofhighertaxation.Itshouldbeusedtoredeemthedebtheldbythecentralbankof the country. This would have the effect of reducing the supply of money in the community and, in turn,reducingthepressureonthepricelevel.Inpractice,however,thescopeforsurplusbudgeting isextremelylimited. Appraisalofantiinflationaryfiscalpolicy: Fiscalmeasuresarenotwhollysuccessfulinpreventinginflationintimesofwarorinperiodsofrapid economicdevelopment.Largegovernmentexpenditureisinevitableinsuchconditionsandacertain amount of deficit financing may have to be allowed. In case of developing countries because of

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heavy investments in long term projects incomes are generated much ahead of the availability of goodsandservices.Thereductionofdemandthroughcontrolofpublicexpenditurehasthuslimited scope. Increase in tax rates maydiscourageproduction and publicborrowing also has itsown limitations. Total effect of all these measures may just help in reducing the inflationary pressure but not in completeeliminationofit. 12.5.4 FiscalPolicy ToControlDepression Lord Keynes maintains that a business depression and unemployment are due to deficiency of aggregatedemandandstronglyadvocatestheuseoffiscalpolicytomakeupthisdeficiency. Thereshouldbeareductioninpersonalincometaxandcorporatetaxwhichwillpromotesavingand investmentandexciseandsalestaxeswhichwillpromoteconsumption. During depression tax reductionalone isnot adequateto push up consumption and investment to appropriate levels, the government can make up this shortage through increase in public expenditure.Governmentbyinvestinginpublicworksprogrammes,socialandeconomicoverheads canencouragebusinessmenandindustrialiststotakeupnewinvestmentactivity.Sincepublicworks programmes cannot be continuedfor a long period and beyond certain limits some social security schemes, unemployment insurance, pension, subsidies of various types can also be provided to raisethelevelofconsumption. Public borrowing, debt servicing and debt repayment also serve as important measures to fight depressionandcyclicalunemployment. Fiscal policy as an instrument to fight depression and create full employment conditions is much more effective than monetary policy, since it affects the level of effective demand directly, while monetarypolicyattemptstodoitonlyindirectly. SelfAssessmentQuestion3 1. Theimportanceoffiscalpolicyasaneconomictoolwasrealizedonlyafter_____in1930s. 2. ____arecalledbuiltinstabilizerstocorrectandthusrestoreeconomicstability. 3. Taxonindividualiscalled___andtaxoncommodityiscalled___ 4. ___leadstoareductionintheunequaldistributionofincome

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5. Taxesdeterminedonthebasisofthevalueofaparticularproductarecalled____.

12.6.PhysicalPolicyOrDirectControls Governmentinterferencewiththeforcesofdemandandsupplyinthemarketandstateregulationof pricesofcommoditiesarecommonfeaturesinthesedays.Thuswhenmonetaryandfiscalmeasures are inadequate to control prices government resorts to direct control. During the war, when inflationaryforcesarestrongpricecontrolinvolve,imposingceilingsinrespectofcertainpricesand pricesaretobestoppedfromrisingtoohigh.Inaplannedeconomy,theobjectiveofpricecontrolis tobringaboutallocationofresourcesinaccordancewiththeobjectsofplan.Pricecontrolnormally involves some control of supply or demand or both. These are done by control of distribution of commoditiesthroughrationing.Rationingis,therefore,anessentialpartofpricecontrolpolicy.Inthe U.S. price control takes the form of price support programme in which prices are prevented from fallingbelow certain levels consideredfair. Under certain circumstances government may resort to dualpricing,whichisyetanotherformofpricecontrolbythegovernment. 12.6.1.InstrumentsOfPhysicalPolicy Directcontrolsareimposedbygovernmenttoensureproperallocationofscarceresourceslikefood, rawmaterials,consumergoods,capitalgoodsetc.Governmentcanstrictlyforbidorrestrictcertain kinds of investments or economic activity. During the period of inflation government can directly exercise control over prices and wages. During WorldWar II, pricewage controls were employed along with consumer rationing to curb excess demand. Monetary and fiscal controls will have a general impactonthe economy while physical controls can be employed toaffect specific scarcity areas. GenerallyDirectControlsareofthreeforms: Controloverconsumptionanddistributionthroughpricecontrolandrationing. Controloverinvestmentandproductionthroughlicensingandfixingofquotasetc. Controloverforeigntradethroughimportcontrol,importquotas,exportcontrol,etc.

During the war period there will be a terrific increase in the demand for certain commodities causinga steep rise inpricesof such commodities,further, this is intensified by the warfinancing, allowing surpluspurchasingpower inthe economy. Price controlattempts to check the inflationary
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riseinprices,enableallcitizenstogetaminimumofcertainbasicnecessariesoflifeandservesas aneffectiveinstrumentofresourcemobilization. Government mayfix ceiling pricesfor various commodities. If government is forced to revise such prices from time to time, it may lead to hoarding and blackmarketing. It requires government to exercisesomecontroloversupplyanddemand.Thestatemayhavetocompulsorilyacquiresome stocks of controlled commodities and distribute them through fair price shops, known as public DistributionSystem. Since there is a close link between commodity market and factor market, under emergency conditions,governmentmayresorttocontrolofprofit,interest,rentandwages. Whenpricesarefallingintimeofdepression,thereispressureforgovernmenttofixminimumprices. In case of some farm products, when there is a bumper harvest, farmers demand for minimum support prices to avoid excessive loss. Subsidies are granted to some farm as well as industrial productstoenablethemtomeettheircosts. Under certain special circumstances Dual Pricing is adopted, there are two prices for the same commodityat the same time one is a controlled pricefixed bythe governmentfor the benefit of lower income groups and the other is afree marketpricedetermined by the conditionsof demand andsupply,whichenablestheproducerstomakeuptheirlossinthecontrolledmarket. Apart from these there are Administered Prices , fixed by the government on a few carefully selectedgoodslikesteel,aluminium,fertilizers,cementetc.whichserveasrawmaterialsforother industriesandfluctuationsintheirpricesisdangerousforthegrowthofsuchindustries. Control over investment and production is equally essential. Factors ofproduction are allocated to industrialconcernsinaccordancewiththeirrequirements.Prioritiesarelaiddowninaccordancewith theimportanceofcommoditiesproducedbydifferentindustries. Stringent measures are taken against hoarding and blackmarketing. To overcome the short term scarcity generally essential goods are imported to meet the excess demand. Reduction of excise duties, granting of tax concessions, credit facilities, supply of raw materials are some of the measuresadoptedtoencourageproduction,inthelongrun. Globalizationandliberalizationpolicieshavemadecontroloverforeigntradeamoresensitiveissue. Interventionofthegovernmentintheforeignexchangemarketneutralizingtheforcesofdemandand

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supplynowhaslostitssignificance.Importduties,i.e.,levyingtariffsonimportstodiscouragesuch imports,ImportQuotas,i.e.,fixingofmaximumquantityofacommoditytobeimportedduringagiven period havebecome morepopular as direct control measures. Besides exports may be promoted, throughreductionofexportduties,useofexportbountiesandsubsidiesandsoon,ifcertaingoods arefoundessentialfordomesticconsumption,thenexportofsuchgoodscanbeprohibited. Advantagesofdirectcontrols

1. Theycanbeintroducedquicklyandeasilyhencetheeffectsofthesecanberapid. 2. Directcontrolscanbemorediscriminatorythanmonetaryandfiscalcontrols. 3. Therecanbevariationintheintensityoftheoperationofcontrolsfromtimetotimeindifferent

sectors. Disadvantages

1. Directcontrolssuppressindividualinitiativeandenterprise. 2. Theytendtoinhibitinnovations,suchasnewtechniquesofproduction,newproductsetc. 3. Direct controls may induce speculation which may havedestabilizing effect. It thus encourages
thecreationofartificialscarcitythroughlargescalehoardings.

4. Directcontrolsneedacumbersome,honestandefficientadministrativeorganizationiftheyareto
workeffectively.

5. Grossdisturbancesmayappearwhenthecontrolsareremoved.
Inbrief,directcontrolsaretobeusedonlyinextraordinarycircumstanceslikeemergenciesandnot inapeacetimeeconomy. Allmeasuressuggestedabovemustbecarefullycoordinatedandimplementedtoachieveeconomic stabilization.Itmaynotbepossibletoeliminateallfluctuationsinemployment,outputandpricesbut canbecontrolledreasonablyifmeasuresareeffectivelyadopted. SelfAssessmentQuestions4 1. Distributionofessentialcommoditiesthroughfairpriceshopsisknownas___________. 2. Importcontrolsareexecutedthroughasystemof_____and_________. 3. Existenceoftwopricesforthesamecommodityatthesametimeonecontrolledpriceanother freemarketpriceiscalled_____________________.
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12.7 Summary
Stableeconomicconditionsareaprerequisiteforasystematicandsmootheconomicgrowth.Since fluctuations are inherent in a dynamic set up, deliberate policy measures become necessary to establish stable conditions in the economy. Stabilization policies include monetary policy, fiscal policyandphysicalpolicy. Monetarypolicyisthepolicyofthecentralbank,itconsistsifusingsuchinstrumentsasbankrate, openmarketoperations,variablereserveratioandselectivecreditcontrolslikemarginrequirements, moral suasion, direct action, rationing of consumer credit, etc. to regulate the supply of money in accordance withthe requirements of the economy. Theprincipal objectives of monetary policy are pricestability,exchangestability,eliminationofcyclicalfluctuations,achievementoffullemployment andincaseofunderdevelopedcountries,acceleratingeconomicgrowth,controllinginflationdeflation etc.Monetarypolicytobeeffectiveinimpartingeconomicstabilitythereshouldbeawellorganized andwelldevelopedmoneymarket. Fiscal policy or the budgetary policy of the government refers to the policy of the government regardingtaxation,publicexpenditure,andmanagementofpublicdebt.Thereisageneralbeliefthat government can influence economic and business activity through fiscal measures. The major objectivesoffiscalpolicyaretoachieveoptimumallocationofeconomicresources,bringaboutequal distribution of income and wealth, maintain price stability, Promote and achieve full employment, promotesavingandinvestment,controlinflation,controldepressionetc.Variousinstrumentsoffiscal policy like taxation and public expenditure have their own limitations in stabilizing the economic growth. Physicalpolicyreferstodirectcontrolondifferentactivitiesbythegovernmenttoachievethedesired goal.Itismorespecific,simpleanddirectcomparedtothemonetaryandfiscalpolicies.Government, controls consumption and distribution of essential goods like food and raw material through price control and rationing. Direct controls are used generally to tide over a situation of shortage or surplus, to avoid large fluctuations in the prices of essential commodities. Investments in certain fields and foreign trade is regulated through licensing, fixing of quotas, import controls, export controls,exportpromotion,etc.

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TerminalQuestions 1. WhatisMonetarypolicy?Explainthegeneralobjectivesofmonetarypolicy. 2. Explainthevariousinstrumentsthroughwhichmonetarypolicyoperates. 3. Discusstheobjectivesandinstrumentsoffiscalpolicy. 4. Explaintheroleoffiscalpolicyineconomicdevelopment. 5. Writeashortnoteonphysicalpolicy. AnswertoSelfAssessmentQuestions SelfAssessmentQuestions1 1. Pricestability 2. CentralBank 3. QuantitativeandQualitativetechniques. SelfAssessmentQuestions2 1. BankRateorDiscountRate 2. Statutoryreserve. 3. ExcessReserve 4. Qualitativeinstrumentsofmonetarypolicy SelfAssessmentQuestions3 1. GreatDepression 2. Automaticstabilizers 3. Directtaxandindirecttaxorcommoditytax 4. Regressivetax 5. Advaloremtax SelfAssessmentQuestions4 1. Publicdistributionsystem. 2. quotasandlicenses 3. Dualpricing.

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AnswerstoTerminalQuestions 1. Refertounit12.4 2. Refertounit12.4 3. Refertounit12.5 4. Refertounit12.5.1 5. Refertounit12.6

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