ECONOMIC POLICY- MONETARY AND FISCAL

DR. SK LAROIYA UNIV OF DELHI AND AMITY BUSINESS SCHOOL

ECONOMIC POLICY

A SET OF INSTRUMENTS USED BY THE GOVERNMENT TO ACHIEVE ITS PRE-DETERMINED

SET OF OBJECTIVES (OBJECTIVE FUNCTION) IS TERMED AS ECONOMIC POLICY

ECONOMIC POLICY..CONTD

THE IMPACT OF ECONOMIC POLICY IS ALWAYS ANALYZED IN THE FRAMEWORK OF MACRO-ECONOMIC ENVIRONMENT – GENERAL EQUILIBRIUM

ECONOMIC POLICY..CONTD

ECONOMIC POLICY IS NECESSARILY A

SECOND BEST APPROACH

ECONOMIC POLICY..CONTD

ECONOMIC POLICY IS ALWAYS SUBJECT TO TWO CONSTRAINTS:

• RESOURCE CONSTRAINT

• POLITICAL CONSTRAINT

ECONOMIC POLICY..CONTD

• THE FIRST CONSTRAINT IS RELAXABLE

• THE SECOND ONE IS BINDING

ECONOMIC POLICY..CONTD

THIS LEADS TO CONSTRAINED MAXIMIZATION OF THE OBJECTIVE FUNCTION OF ECONOMIC POLICY

WHY ECONOMIC POLICY ?

• MARKET IMPERFECTIONS

• DISTORTIONS

• EXTERNALITIES

• INCOME DISTRIBUTION

ANALYSIS

• WHILE ANALYZING THE EFFICACY OF ECONOMIC POLICY, WE MUST FOCUS ON

• OBJECTIVES

• INSTRUMENTS

• MECHANISM

• UNDERLYING ASSUMPTIONS AND LIMITATIONS

ANALYSIS..CONTD

AN APPROPRIATE POLICY MIX – OPTIMAL POLICY MIX MUST BE DESIGNED SO THAT ECONOMY IS MANAGED EFFICIENTLY

VARIANTS OF ECONOMIC POLICY

• FISCAL POLICY

• MONETARY POLICY

• WAGE POLICY

ANALYSIS

• MAXIMIZING ECONOMIC GROWTH

• FULL EMPLOYMENT

• PRICE STABILITY

• BALANCE IN BALANCE OF PAYMENTS

• SOCIAL JUSTICE

OBJECTIVES OF ECONOMIC POLICY.. CONTD

• COMPATIBILITY/INCOMPATIBILITY AMONG THE POLICY OBJECTIVES

• THE CONCEPT OF TRADE OFF

• RANGE OF TRADE OFFS

MONETARY POLICY

OBJECTIVES: TO PROVIDE NECESSARY FINANCE TO VARIOUS

INVESTORS THROUGH EFFICIENT BANKING SYSTEM FOR ECONOMIC DEVELOPMENT

FULL EMPLOYMENT PRICE STABILITY STABILITY OF EXCHANGE

MONETARY POLICY ..CONTD

CONTROL OF BUSINESS CYCLES

ECONOMIC GROWTH

THERE ARE FOUR MAIN “CHANNELS” WHICH THE RBI LOOKS AT:

1. QUANTUM CHANNEL:

MONEY SUPPLY AND CREDIT ( AFFECTS REAL OUTPUT AND PRICE LEVEL THROUGH CHANGES IN RESERVE MONEY, MONEY SUPPLY AND CREDIT AGGREGATES

2. INTEREST RATE CHANNEL

3. EXCHANGE RATE CHANNEL 9 LINKED TO CURRENCY)

4. ASSET PRICE

IMPACT OF MONETARY POLICY:

1. CHANGE IN CRR ON INTEREST RATES

2. CHANGE IN SLR AND GILT PRODUCTS ON INTEREST RATES

3. ON DOMESTIC INDUSTRY AND EXPORTERS

4. ON STOCK MARKETS AND MONEY SUPPLY

5. ON EMPLOYMENT, WAGES AND OUTPUT

ALTERNATIVE DESIGNS OF MONETARY POLICY

MONETARY POLICY DESIGN DESCRIPTION OF THE POLICY

RESTRICTIVE MONETARY POLICY SEEKS TO CONTROL AGGREGATE DEMAND WITH THE BASIC PURPOSE TO CONTROL INFLATION

EXPANSIONARY MONETARY POLICY SEEKS TO STIMULATE AGGREGATE DEMAND TO BOOST THE ECONOMY

CONTRA CYCLICAL MONETARY POLICY SEEKS TO EXPAND AND RESTRICT AGGREGATE DEMAND ALTERNATIVELY TO CONTROL BUSINESS CYCLES

RULE BASED MONETARY POLICY ACTIONS ARE BASED ON PREDETERMINED SET OF RULES FOR DIFFERENT SITUATIONS

DISCRETIONARY MONETARY POLICY PROVIDES DISCRETION TO CENTRAL BANKING AUTHORITIES IN MONETARY POLICY ACTIONS. ACTION IS TAKEN ACCORDING TO THE EXIGENCIES OF THE EMERGING SITUATION

INSTRUMENTS OF MONETARY POLICY

QUANTITATIVE CONTROLS

BANK RATE

OPEN MARKET OPERATIONS

CASH RESERVE RATIO

SLR- BANKS IN INDIA ARE REQUIRED TO MAINTAIN 25% OF THEIR DEMAND AND TIME

LIABILITIES IN GOVERNMENT SECURITIES AND CERTAIN APPROVED SECURITIES. THESE ARE COLLECTIVELY KNOWN AS SLR SECURITIES. THE BUYING AND SELLING OF THESE SECURITIES LAID THE FOUNDATIONS OF HARSHAD MEHTA SECURITY SCAM OF 1992

INSTRUMENTS OF MONETARY POLICY .. CONTD

SELECTIVE OR QUALITATIVE CONTROLS:

MARGIN REQUIREMENTS

CONTROL THROUGH DIRECTIVES

REGULATION OF CONSUMER CREDIT

RATIONING OF CREDIT

DIRECT ACTIONS

FISCAL POLICY

ECONOMIC DEVELOPMENT ISSUES AND FISCAL POLICY-

AN INDIAN EXPERIENCE

OBJECTIVES OF FISCAL POLICY:

1. TO MOBILIZE ADEQUATE RESOURCES FOR FINANCING VARIOUS PROGRAMS AND PROJECTS FOR ACHIEVING TARGET RATE OF ECONOMIC GROWTH/ DEVELOPMENT

2. TO RAISE THE SAVINGS AND INVESTMENT FOR INCREASING THE RATE OF CAPITAL FORMATION

3. TO PROMOTE NECESSARY DEVELOPMENT IN THE PRIVATE SECTOR THROUGH FISCAL INCENTIVE

4. TO ARRANGE OPTIMUM UTILIZATION OF RESOURCES

5. TO CONTROL INFLATIONARY PRESSURE IN THE ECONOMY IN ORDER TO ATTAIN ECONOMIC STABILITY

6. TO REDUCE REGIONAL DISPARITIES

7. TO REDUCE THE DEGREE OF INEQUALITY IN THE DISTRIBUTION OF INCOME AND WEALTH

COMPONENTS OF FISCAL POLICY

GOVERNMENT EXPENDITURE

GOVERNMENT REVENUE

DIRECT TAXES

INDIRECT TAXES

SUBSIDIES

DEFICIT

DEBT MANAGEMENT

DIRECT TAXES

PERSONAL INCOME TAX:

TAX IMPOSED ON THE INCOME OF AN INDIVIDUAL WHICH IS DERIVED FROM VARIETY OF SOURCES

IT COULD BE REGRESSIVE, PROGRESSIVE OR PROPORTIONAL

CORPORATION TAX:

THE TAX IMPOSED ON THE ASSESSABLE PROFITS OF THE COMPANIES AND UNINCORPORATED ASSOCIATIONS

GENERALLY CALCULATED AFTER INTEREST BUT BEFORE DIVIDEND DISTRIBUTION

COMPANIES ALSO LIABLE TO PAY CAPITAL GAINS TAX

INHERITANCE TAX:

THE TAX ON THE TRANSFER OF WEALTH ON THE DEATH OF THE DECEASED INDIVIDUAL TO THE OTHERS LIVING

ALSO CALLED AS DEATH DUTY OR ESTATE DUTY

WEALTH TAX:

TAX PAID ON THE SPECIFIED STOCK OF ASSETS HELD BY AN ECONOMIC UNIT THAT YIELDS OR HAS POTENTIAL TO YIELD INCOME IN SOME FORM

INDIRECT TAXES

EXCISE DUTY:

THE TAX LEVIED ON THE PRODUCTION OF GOODS

LEVIED BY CENTRAL GOVERNMENT IN INDIA

VAT- VALUE ADDED TAX: A GENERAL TAX APPLIED AT EACH POINT OF EXCHANGE FROM PRIMARY

PRODUCTION TO FINAL CONSUMPTION

ASSESSED AND IMPOSED ON THE DIFFERENCE BETWEEN THE SALE PRICE OF GOODS OR SERVICES (OUTPUTS) TO WHICH THE TAX IS APPLIED AND THE COST OF GOODS AND SERVICES (INPUTS) BOUGHT IN ITS PRODUCTION

THE COST OF THE INPUTS INCLUDE ALL THE CHARGES INCLUDING THE TAXES (EXCEPT VAT ITSELF)

CUSTOM DUTY

SALES TAX

SERVICE TAX

NECESSARY REFORMS IN FISCAL POLICY- A FEW RELEVANT ISSUES

1. PROGRESSIVE TAXES

2. AGRICULTURAL TAXATION

3. BROAD BASED TAX NET

4. CHECKING TAX EVASION

5. INCREASING RELIANCE ON DIRECT TAXES

6. SIMPLIFICATION OF TAX STRUCTURE

7. REDUCTION IN NON-DEVELOPMENTAL EXPENDITURE

8. CHECKING BLACK MONEY

9. RAISING PROFITABILITY OF PSUs

9. RATIONALIZATION OF DIRECT TAX RATES

10. REFORMS IN INDIRECT TAXES – GST ETC.

11. CONTROL OF GOVERNMENT EXPENDITURE

12. RATIONALIZATION AND REDUCTION IN GOVERNMENT SUBSIDIES

13. REDUCTION IN FISCAL DEFICIT

14.REDUCTION IN PUBLIC DEBT

15. DISINVESTMENTS IN THE PUBLIC SECTOR