Macroeconomic Policy

Monetary Policy
Fiscal Policy
 Monetary Policy

Regulation of money supply by the central bank of the country

through the use of deliberate discretionary action for achieving
the objectives of general economic policy.
 Objectives of monetary policy

Price stability- ensures steady growth in production and

employment, and promotes trade.
Healthy balance in balance of payments-
Full employment and maximum feasible output
High rate of growth
Greater equality in income distribution
 Instruments of monetary policy

1. Open market operations

- purchase and sale of securities by the central bank.
direct influence on money supply in circulation and
commercial banks cash reserve.
when central bank offers securities for sale, it intends to contract
the quantity of money and credit.
An expansionary monetary policy by the central bank will buy
securities in the market more money in circulation,
increase in cash reserves of commercial banks which
increases their capacity to create credit.
Impact of open market operations are on deposits of commercial
banks with the central bank and on the customers deposits
with the commercial banks.
2. Cash Reserve Ratio (CRR-4%)- the portion of deposits as
cash that banks have to keep with RBI. It is risk free and helps
RBI to check in liquidity in the system.
- the higher the CRR, less money with banks for lending and
investment.
3. Statutory Liquidity Ratio (SLR-19.5%)- the minimum
percentage of deposits that the bank has to maintain in form of
gold, cash or other approved securities.
-an increase in SLR reduces banks power to lend money.
4. Repo rate (6%) is the rate at which banks borrow funds from
the RBI, due to shortage of funds.
- If the RBI wants to make it more expensive for the banks to
borrow money, it increases the repo rate; similarly, if it wants
to make it cheaper for banks to borrow money, it reduces the
repo rate(more money into circulation).
Reverse repo rate(5.75%) - the rate at which RBI borrows money from
the banks (or banks lend money to the RBI), if it finds excess money in the
banking system.
- or it is the interest rate that banks receive if they deposit money with the
RBI.
- an increase in reverse repo rate leads to higher returns for banks.

5. Bank rate policy(6.25%)

- long term rate at which central bank (RBI) lends money to other banks or
financial institutions.
- this is used as an instrument for credit control with the assumption that
market rates of interest invariably respond to changes in bank rate.
If bank rate is raised , other interest rates rise in response and borrowing
becomes less profitable which results in contraction of credit.
A reduction in bank rate fall in market interest rates , raises the profitability
of borrowing , and expansion of credit.
The efficiency of the bank rate policy is less in developing countries. This
often results in speculation, hoarding and inventory build-up rather than
investment activity and expanded output.
Marginal Standing Facility (MSF-6.25%)-
a special window for banks to borrow from RBI against approved
government securities in an emergency situation like an acute
cash shortage. MSF rate is higher then Repo rate.
 Fiscal Policy

- policy of the government regarding taxation, public borrowing

and public expenditure with specific objectives in view.
Objectives
1. Increasing the rate of investment
2. Encouraging a socially optimum pattern of investment
3. Reducing inequalities in income
4. Reducing unemployment and underemployment
5. Controlling inflationary tendencies
 Instruments of Fiscal Policy

1. Taxation
Direct taxes(personal income tax, corporate income tax, taxes
on property and wealth) and indirect taxes (sales tax, excise
and customs duties)
Personal income tax
Corporate income tax
Property taxes
Taxes on commodities
2. Public Expenditures
Expenditure on infrastructural activities
Expenditure on agricultural sector
Expenditure on welfare activities
 Inflation
- rate at which the general level of prices for goods and services
is rising.
- reduction in purchasing power.
Causes
Demand pull inflation- caused by increases in aggregate
demand due to increased private and government spending.
Cost push inflation- also called "supply shock inflation" is
caused by a drop in aggregate supply (potential output). This
may be due to increased prices of inputs or natural disasters.