Changes in fiscal and monetary policies before and post recession

Topics: Monetary policy, Inflation, Public finance Pages: 6 (1009 words) Published: December 3, 2013
CHANGE IN FISCAL AND MONETARY POLICIES OF INDIA DURING AND POST-RECESSION

Introduction

The state of an economy dominates the national and world news. An economy fluctuates due to unemployment rates, rise and fall of stock markets and demand for goods and services. Directly affects citizens, industry, and banking.

Policymakers: The central bank and Government intervene by altering government spending, raising or lowering taxes, and changing the money supply in an attempt to stabilize the economy. These interventions often do not affect the economy immediately The control measures constitute the fiscal and monetary policy. Fiscal Policy

Means by which a government adjusts its levels of spending in order to monitor and influence a nation's economy Two main instruments:
Government Expenditure: government intervention designed to promote allocated efficiency through correction of market failures, redistribute resources equitably and promote economic growth and stability Taxation: Tax cuts made to increase disposable income and hence aggregate expenditure Expansionary Fiscal Policy

Government Expenditure
Tool to cure recession
Increase in expenditure
Public works
Building roads, dams ports
Telecommunication
Purchase of goods
Effect
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Increase in Income ==> Increased Consumption

Taxation
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Decrease in Tax Rates ==> Increase in Expenditure ==> Increase in Aggregate income

Contractionary Fiscal Policy

Government Expenditure
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Decrease in expenditure ==> Reduction in Aggregate Income

The Union budget passed in February 2010, it is clear that the expenditure from the government will be directed towards improving the overall productivity of the nation and will not be focussed on boosting economy.

Taxation

Increase in Tax Rates ==> Decrease in Expenditure ==> Decrease in Aggregate income

Union Budget changes in Tax Rate s 2010-2011

Customs
Crude and refined edible oils: The taxes were increased to 5%, which were made ‘Nil’ earlier. Petrol and diesel: Tax was increased from 2.5% to 7.5%.
Petroleum products: Increase from 5% to 10%.
Central Excise Duty
Excise duty was reduce from 16% in 2007 – 2008, to 8% in January 2009. To control inflation the government has announced a further increase in excise duty to 10%, as on March 1, 2010.

Statistical Analysis

Fiscal stimulus package has been used as the dummy variable in developing the regression model to analyse its impact on the GDP of India in 2008 and 2009. Following data has been used to run the regression:

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Results

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Let us consider the following figures to calculate government expenditure multiplier -

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Thus, the income multiplier explains us that due to change in above 2 components, the total income or GDP increases by U.S $94.335 billion (84.321+10.01388). Actual increase in GDP in 2008 from 2007 is U.S. $134.99 billion (1235.98 – 1100.99). The difference of U.S. $40.655 billion (134.99 – 94.335) can be explained by other changes in monetary base and negative (or close to zero) MPM during recession.

Monetary Policy

Monetary policy is the process by which monetary authority/central bank of a country controls the supply of money, often targeting a rate of interest to attain a set of objectives oriented towards growth and stability of the economy

Measures taken by the central bank are as follows –

Reserve ratios – SLR and CRR
Short term credit ratios – REPO RATE and REVERSE REPO RATE Open Market Operations
Market Stabilization Scheme
Boom Period – 2007

Year 2007 was a boom period in India but at the same time it was a period of unstable financial markets in the West

Monetary policy in 2007 was facing the dual challenge of inflationary pressures emanating from escalating global commodity and food prices, and heightened downside risks to growth arising from unstable global financial markets

This was the reason to take the...
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