Monetary and Fiscal Policy is used to control money supply in the system in India as well as the world. Monetary and Fiscal Policy for UGC NET exam is a very crucial topic as they form the backbone of economic management. In the field of economics, Monetary and Fiscal Policy are two fundamental tools that governments and central banks use to regulate economic activity, control inflation, and drive growth. This article explains the objectives, tools, and impacts of Monetary and Fiscal Policy, helping UGC NET Commerce students grasp these critical concepts for UGC NET Commerce exam.
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Monetary and Fiscal Policy for UGC NET
In India, economic policies is broadly categorized into Monetary and Fiscal Policy. Monetary and Fiscal Policy of India guide how resources are allocated, how financial stability is maintained, and how economic development objectives are pursued. Monetary Policy in India is prepared and implemented by the Reserve Bank of India (RBI) whereas Fiscal Policy is managed by the Ministry of Finance. This is the reason why Monetary and Fiscal Policy for UGC NET is a very pivotal.
Monetary Policy for UGC NET
The topic Monetary Policy for UGC NET will cover objective, tools and other important details of the monetary policy laid by RBI (Reserve Bank of India). Monetary Policy Committee of RBI is responsible for creating monetary policy in India.
Objective of Monetary Policy
- It manages money supply and interest rates in India
- It helps in balancing inflation, liquidity, saving investments, consumptions, etc, in the system.
- It also plays important role in economic growth, price stability, job creation and social justice.
What is MPC (Monetary Policy Committee)?
MPC (Monetary Policy Committee) of India is a RBI committee of RBI, responsible for fixing the benchmark interest rate in India. Here are some of the details about Monetary Policy Committee of India:
- Section 45ZB of the amended Reserve Bank Act, 1934 provides 6-member monetary policy committee (MPC) to achieve the inflation target.
- Monetary Policy Committee (MPC) is required to meet at least 4 times a year.
- Monetary Policy Committee (MPC) is a 6-member body and is headed by the governor of RBI.
- 3 members from RBI
- 3 members nominated by Central Government.
Current Members of Monetary Policy Committee (MPC)
There are six members in the current MPC:
- Shaktikanta Das (Governor of the Reserve Bank of India (RBI)), serving as Chairperson.
- Michael Patra (RBI member)
- Rajeswari Sengupta (RBI member)
- Prof. Ram Singh (Government Nominated)
- Saugata Bhattacharya (Government Nominated)
- Dr. Nagesh Kumar (Government Nominated)
Instruments of Monetary Policy for UGC NET
Instruments of Monetary Policy are divided into two parts:
- Quantitative Instruments: It influence the total volume of the credit.
- Qualitative Instruments (Selective Tools): They are used for discriminating between different uses of credit and can have influence over the lender and borrower of the credit.
Quantitative Instruments of Monetary Policy
- Cash Reserve Ratio (CRR):
- It represents the minimum amount of funds that banks must maintain with the Reserve Bank of India (RBI), expressed as a percentage of their Net Demand and Time Liabilities (NDTL).
- NDTL consists of:
- Time Liabilities: Fixed deposits, term deposits, and similar funds.
- Demand Liabilities: Savings and current account deposits, along with demand drafts.
- This amount cannot be used for lending or investment by the bank.
- For example, if a bank receives ₹100 in deposits and the CRR is set at 4%, it must hold ₹4 with the RBI, leaving ₹96 available for lending or investment.
- A high level of CRR means banks will have fewer funds available for lending, which can affect the economy’s liquidity.
- Banks do not earn any interest on the CRR.
- The Monetary Policy Committee (MPC) determines the CRR for scheduled commercial banks, although the RBI can set specific requirements for Regional Rural Banks (RRBs) as well as Cooperative Banks.
- When the CRR is decreased, banks are allowed to use more of their funds for lending, which can increase the money supply in the economy.
- Statutory Liquidity Ratio (SLR):
- SLR requires commercial banks to maintain a specified percentage of their Net Demand and Time Liabilities (NDTL) in liquid assets, like cash, gold, or government-approved securities.
- This ensures that banks don’t lend out all their deposits, mitigating risks.
- An increase in SLR indicated banks must hold more of their deposits in reserve and thus have less money available for lending
- A decrease in SLR gives banks more funds to lend, stimulating credit expansion and economic activity.
- Open Market Operations (OMO)
- Open Market Operations (OMO) involve the RBI buying or selling government securities, bills, and bonds in the open market to influence the money supply and liquidity in the economy.
- To inject liquidity in the banking system, RBI purchases government securities by paying cash, which increases money supply.
- When the RBI sells securities through OMO, it absorbs liquidity from the market, reducing the money supply.
- Market Stabilizing Scheme (MSS)
- Under the Market Stabilizing Scheme (MSS), the RBI sells government securities, treasury bills, and cash management bills to absorb excess liquidity in the system.
- The money generated from these sales does not contribute to the government’s borrowing but earns interest, which the government must pay.
- Liquidity Adjustment Facility (LAF)
- The Liquidity Adjustment Facility (LAF) is a tool used by the RBI to manage short-term liquidity in the banking system.
- It includes two instruments:
- Repo Rate: The interest rate at which the RBI lends money to commercial banks against government securities, typically for a short term (2-3 months). A reduction in the repo rate makes borrowing cheaper for banks, encouraging lending.
- Reverse Repo Rate: The rate at which the RBI borrows money from commercial banks against government securities. An increase in the reverse repo rate incentivizes banks to park more funds with the RBI, which helps absorb excess liquidity from the system.
- Marginal Standing Facility (MSF)
- Marginal Standing Facility (MSF) allows commercial banks to borrow funds from the RBI in times of emergency, even if they don’t have the necessary securities beyond the SLR requirement.
- Under MSF, banks can borrow up to 2% of their Net Demand and Time Liabilities (NDTL), providing short-term relief in times of liquidity shortage.
- Minimum borrowing size: ₹1 crore, with subsequent increments in multiples of ₹1 crore.
- Bank Rate
- The Bank Rate is the rate at which the RBI lends long-term loans to commercial banks, typically for rediscounting bills of exchange and government securities.
- Unlike Repo Rate, Bank Rate is used for long-term lending and serves as a broader tool to regulate the economy.
- Long-Term Repo Operations (LTRO)
- Long-Term Repo Operations (LTRO) are used by the RBI to provide long-term funds (ranging from 1 to 3 years) to banks at the prevailing repo rate.
- It is designed to enhance liquidity in the banking system by offering long-term funding at a predictable interest rate, facilitating the flow of credit to businesses.
- LTROs are provided through the RBI’s e-Kuber platform, and the minimum amount that can be borrowed under LTRO is ₹1 crore.
Qualitative Instruments of Monetary Policy
Here are some of the qualitative instruments of Monetary Policy used by the Reserve Bank of India (RBI):
- Margin Requirements: It is designed to control the size and flow of credit to various sectors. It can be used to channel credit towards priority sectors, such as agriculture.
- Regulation of Consumer Credit: This tool governs the supply of consumer credit by regulating hire-purchase and installment payments for goods.
- Publicity: Publicity serves as a selective credit control method and RBI uses its reports and bulletins to influence the credit distribution decisions of commercial banks.
- Credit Rationing: Under this method, RBI limits the total amount of credit available to each commercial bank.
- Moral Suasion: It is a non-coercive method where the RBI persuades commercial banks to align their lending practices with the central bank’s policy goals.
- Control Through Directives: Under this tool, the RBI issues specific instructions to commercial banks regarding their lending policies.
- Direct Action: When a bank fails to comply with the RBI’s directives or violates banking regulations, RBI can take direct action.
Fiscal Policy for UGC NET
Economic Fiscal Policy for UGC NET deals with the government policy concerning changes in taxation and expenditure overheads and components.
Objectives of Fiscal Policy in India
- Fiscal Policy of India helps to maintain economy’s growth rate so that certain economic goals can be achieved
- Fiscal Policy of India controls price level so that when the inflation is too high, prices can be regulated.
- Fiscal Policy of India aims to achieve full employment, or near full employment, as a tool to recover from low economic activity.
Types of fiscal policy
- Expansionary fiscal policy:
- This type of policy is designed to boost the economy and is mostly used in times of high unemployment and recession.
- It encourage government to lower taxes and spend more, or one of the two with the aim to stimulate the economy and ensure consumers’ purchasing power does not weaken.
- Contractionary fiscal policy:
- This type of policy is designed to decrease economic growth in case of high inflation by raising taxes and cuts spending.
Instruments of Fiscal Policy
- Government Spending
- It is one of the main tools of fiscal policy.
- The government spends on infrastructure, defense, social welfare, health, education, and subsidies.
- Enhanced government spending stimulates economic growth, whereas reduced spending helps control inflation.
- The government also allocates funds for rural development, public sector enterprises, and developmental projects aimed at creating jobs and boosting the economy
- Taxation:
- The government collects revenue through taxes, which include direct taxes (income tax, corporate tax) and indirect taxes (GST, excise duty, customs). The structure and rates of taxes play a critical role in determining economic activity.
- Tax Reforms such as the Goods and Services Tax (GST) have been significant in simplifying the taxation process and improving tax compliance across the country.
- Budget Deficit and Public Debt:
- Fiscal policy of India must also address the issue of the fiscal deficit, which is the difference between the government’s total expenditure and total revenue.
- A high fiscal deficit in India can lead to inflation and higher borrowing costs, while a low fiscal deficit helps to stabilize the economy.
- The Government Debt is managed through long-term borrowing, and the government takes steps to ensure that borrowing is sustainable to avoid excessive pressure on the economy.
Monetary and Fiscal Policy for UGC NET Important Points
Monetary and Fiscal Policy for UGC NET is a very wholesome topic. Following points should be kept in mind for preparing Monetary and Fiscal Policy for UGC NET exam:
- Questions are generally asked from the instruments of Monetary and Fiscal Policy
- Stay yourself updated with the latest monetary policy and budget, before you step up for the exam.
- Read static part for conceptual clarity
- Solve UGC NET Previous Year Question Papers before you go for the exam.
- Go through the UGC NET Commerce Syllabus thoroughly.
Click Here to check UGC NET Commerce Syllabus
Monetary and Fiscal Policy for UGC NET Conclusion
A student who want to ace UGC NET Commerce exam must go through the UGC NET Previous Year Question Papers and UGC NET Commerce Syllabus. After going through these, important topics should be covered. Monetary and Fiscal Policy for UGC NET is one of the most important topic for the UGC NET Commerce exam and questions comes from this topic very frequently. So, don’t forget to read the full article and get UGC NET exam ready.
Reserve Bank of India controls and regulates monetary policy in India.
India’s economic policy can be broadly classified into two categories: Monetary Policy and Fiscal Policy.
The repo rate is the interest rate at which the RBI lends to commercial banks for short-term funding.
The reverse repo rate is the rate at which the RBI borrows from commercial banks, absorbing excess liquidity from the system.
By adjusting interest rates and controlling money supply, monetary policy influences inflation and helps maintain price stability.
The Government of India, through the Ministry of Finance, is responsible for fiscal policy.
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