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Basics of Fiscal policy and Monetary policy UPSC pre

Today we are going to discuss Monetary policy and fiscal policy specifically from UPSC point of view.

 

In End, I am going to discuss a question which was asked in the UPSC pre-exam.

 

Monetary policy vs Fiscal policy

 

The main difference between Monetary policy and Fiscal policy is that

 

Monetary policy is decided by central bank[eg. RBI]

Fiscal policy is decided by Government.

 

Let's discuss the topic in Detail.

 

What is Monetary policy?

 

It is a macroeconomic policy designed by the central bank of a country, to manage money supply & interest rates.


It helps shaping variables such as inflation, consumption, savings, investment, and capital formation

 

 It plays an important role in 

price stability [inflation control], 

economic growth, 

job creation and 

social justice in any economy.

  

Milton Friedman [American economist]-

whose research on monetary policy made this

subject more popular, he also won a Nobel in Economics in this regard (1976).

 

Monetary policy tool

 

Quantitative

Reserves: CRR, SLR

Key Rates (Repo, MSF, Bank Rate)

Market Ops (OMO, MSS)

 

Qualitative

Moral Suasion /Direct Action

Selective CreditControl / Priority Sector Lending(PSL)

Margin Req. / Loan to Value (LTV)---Increase e.g. Gold-LTV: 60% → 90%- i.e loan of upto 90% of value can be given


Why is Inflation good for the Economy?

 

Philip Curve: Inflation ↑ = unemployment ↓ (and vice versa).


Therefore, stable & moderate inflation is good for the economy.

 

So, RBI tries to keep inflation with 2-6% CPI (All India) using its bi-monthly monetary policy made by its 6- member statutory Monetary Policy Committee.

 

What is Fiscal policy?

‘Fiscal’ is a word derived from Greek. Means ‘basket’ and symbolizes the public purse.

 

Fiscal policy is the set of Govt. decisions regarding

taxation,

expenditure,

subsidies and

other financial operations.

 

Fiscal policy Use of taxation, public borrowing [Government borrowing] and public expenditure by the Government for purposes of stabilisation [eg. Exchange rate]or development.

 

Using fiscal policy, Govt influences 

savings, 

investment and 

consumption in an economy, 

to accomplish certain national goals such as

income redistribution [Taxation],

socio-economic welfare [welfare schemes- PM garib kalyan yojana],

economic development[MUDRA Yojana] and

inclusive growth.

 

I have discussed the importance of fiscal policy above but I am repeating it to help you in Pre exam because when you read the same concept in different words then it will be helpful to eliminate the option in pre exam.

 

Why Fiscal policy is important?

 

1. Employment: through schemes like MGNREGA

 2. Fight Inflation: Higher Income tax will decrease disposable income and decrease demand in the market,

 3. To fight deflation: direct and indirect taxes decreased to boost demand.

4. To Boost Economic Growth: Provide income tax benefits on household savings in LIC/Mutual Fund etc.

 

This household financial saving is used by LIC/ Mutual funds to buy bonds, and shares so industries get new capital investment which leads to factory expansion, jobs, and GDP growth.

 

5. To Boost Inclusive Growth: Higher taxes on the rich and use that money for

Health[PM JAY],

Education[Article 21A],

women[Pradhan mantri ujjawala yojana, Stand up India],

poverty removal programs[MGNREGA, Mission Antyodaya].

 

6. To Boost Regionally Balanced Growth :

 

Give tax benefits to industrialists for setting up factories in North East, Left-wing Extremism (LWE) & other backward areas.

 

7. Exchange Rate Stability:

 

Give tax benefits to exporters to boost exports and impose higher taxes on imported items to reduce imports.

 

It will control our Current Account Deficit (CAD) which reduces Exchange rate volatility.

 

Which of them is/are part of Monetary Policy? (Pre-2015)

1) Bank rate

2)Open market operations

3) Public debt

4) Public Revenue

 

(a) 1 only

(b) 2, 3 and 4

(c) 1 and 2

(d) 1, 3 and 4

 

Solution(c)

  

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