Monetary and
Fiscal Policy
or
Business cycle
Central Question:
When the economy is doing
badly,
should
we
do
something to try to fix it, or
should we leave it alone?
Classical Economic Theory:
Classical economics refers to work done by a group of
economists in the eighteenth and nineteenth
centuries. It stressed economic freedom and promoted
ideas such as laissez-faire and free competition.
Classical economists like Adam Smith believed that the
economy is self-regulating: supply and demand
naturally move back to equilibrium when there are
imbalances.
JOHN MAYNARD KEYNES:
1883-1946
Famous British economist
who changed the way we
look at macroeconomics
by promoting the idea
that governments should
try
to
stimulate
the
economy
IDEAS…
•
Optimal economic performance can be achieved (and
economic recessions prevented) by increasing aggregate
demand through economic intervention policies by the
government.
 • The market is imperfect, and not self-sustaining.
 • Consumer income stimulates demand, which causes
economic growth.
 • Thus, when economic growth is lacking, the government
should find ways to stimulate consumer demand.
Tools Used to Influence Aggregate Demand
MONETARY POLICY
MEANING : Monetary policy refers to the steps taken by the RBI to
regulate the cost & supply of money & credit in order to achieve the
socio-economic objectives of the economy. Monetary policy influences
the supply of money the cost of money or the rate of interest and the
availability of money.
OBJECTIVES OF MONETARY POLICY
•
Full Employment
•
Price Stability
•
Economic Growth
•
Balance of Payments
•
Controlled expansion
•
To Regulate and Expand Banking
TOOLS OF MONETARY POLICY
Tools Of Monetary Policy
Bank
Rate : 4.25%
Repo Rate: 4.00%
Reverse Rate: 3.35%
MSF (Marginal Standing Facility):4.25%
Reserve Ratio
Cash Reserve Ratio (CRR): 3%
Statutory Liquidity ratio (SLR): 18.00%
Open Market Operations
Qualitative Measures Selective or Direct
 DIRECT
 MORAL
ACTION
SUASION
 Rationing
 Margin
of Credit
Requirement
 Selective
Credit Controls
How monetary policy works
 The
Central Bank may have an inflation target of
2%. If they feel inflation is going to go above the
inflation target, due to economic growth being
too quick, then they will increase interest rates.
 Higher interest rates increase borrowing costs and
reduce consumer spending and investment,
leading to lower aggregate demand and lower
inflation.
 If the economy went into recession, the Central
Bank would cut interest rates.
How do we increase economic growth?
One way to increase growth is to lower
the interest rates that people pay on loans
and mortgages. If people save money by
paying low rates for the money they must
borrow, they will have more money to
spend: this money will circulate back into
the economy, helping businesses grow
and prosper.
How do we lower inflation?
Raising interest rates on loans and
mortgages helps slow economic growth,
because people will be forced to pay
more when they borrow money from
banks. People have less money to spend
in the economy, the lack of money
flowing into the economy causes
recession, and recession lowers inflation.
FISCAL POLICIES
FISCAL POLICY

•The fiscal policy is concerned with the raising of government revenue and
incurring of government expenditure. To generate revenue and to incur
expenditure.

• To generate revenue and to incur expenditure, the government frames a
policy called budgetary policy or fiscal policy. So, the fiscal policy is
concerned with government expenditure and government revenue.

•Fiscal policy has to decide on the size and pattern of flow of expenditure
from the government to the economy and from the economy back to the
government.

•In broad term fiscal policy refers to "that segment of national economic
policy which is primarily concerned with the receipts and expenditure of
central government.
TYPES OF FISCAL POLICY
OBJECTIVES OF FISCAL POLICY

Efficient allocation of Financial Resources

Development by effective Mobilization of Resources

Reduction in inequalities of Income and Wealth

Price Stability and Control of Inflation

Reduction in inequalities of Income and Wealth

Increase capital

Increase National Income

Foreign Exchange Earnings
EFFECTS OF FISCAL POLICY
Thankyou