Eco project

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A STUDY ON SO-CIO ECONOMIC ROLE OF
MONETARY AND FISCAL POLICY. M.COM MANAGEMENT PART-I
CHAPTER-1
INTRODUCTION
A free market economy was once believed to be capable of functioning without
interference by government; however, it does not automatically establish optimum demand
for goods and services. During the 1920's the quantity theory of money became widely
accepted, and the Federal Reserve was believed to be capable of preventing future "booms"
and "busts." The great depression shattered those hopes, resulting in increased emphasis on
fiscal policy.
In 1946 Congress passed the Full Employment Act, which in effect made the government
responsible for maintaining high levels of employment without inflation. The essential idea
is that the government, through monetary-fiscal policies, should augment or offset private
demand in such a way as to maintain high levels of employment and stable prices. Recently
emphasis has been given to two additional objectives, promoting economic growth and
protecting the balance of payments.
Presently economists generally agree that monetary-fiscal policies should and can be used
to prevent extreme economic fluctuations. Almost all economists agree that monetary
policy should be "tighter" in a period of full employment and inflation than during a period
of under-utilization of economic resources. They also agree that government revenues
relative to receipts should be higher during inflation periods and lower during recessions.
Unfortunately this still leaves much room for disagreement on which of these tools
represents the more potent force, on how tight or how easy money should be in particular
circumstances, and on the most desirable size of the budget deficit or surplus. Also, opinion
differs considerably about length of lags, for both monetary and fiscal policy, between: (1)
recognition of a need for action, (2) taking of action, and (3) eventual impact upon the
economy.

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These issues cannot be settled by logical analysis alone. Empirical evidence must be
brought to bear upon these areas of conflict.
In this discussion I will present the basic theory underlying the fiscal policy approach and
the monetary policy approach, cite what I consider to be the relevant evidence and then
apply my conclusions to the current debate concerning the desirability of a tax cut as well
as the dispute concerning use of monetary policy for reducing a Balance of payments
deficit.

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A) MEANING OF MONETARY POLICY
Having discussed the concept of economic development, now let us define the
monetary policy and describe its objectives. In General, monetary policy means the policy
of credit control and the deliberate management of money supply. As there are different
versions on meaning of economic development, here on monetary policy also various
definitions drawn by different economists. Paul Eizing defines monetary policy as‖ The
attitude of the political authority towards the monetary system of the community under its
control‖.KP Kent has defined ― The Management of the expansion and contraction of the
volume of money in circulation for the explicit purpose of attaining a specific objective,
such as full employment‖ CK Johri states ― Monetary policy comprises those decisions of
Government and the Reserve Bank of India which affect the volume and composition
of money supply, the size and distribution of credit the level and structure of interest rates
and the effects of these variables upon the factors determining output and prices‖ GK Shaw
‗ By Monetary policy we means any conscious action undertaken by the monetary
authorities to change the quantity availability or cost of money‖
We have various definitions, some of them are narrow and some are broad definitions
of monetary policy. CK Johri and GK Shaw gave broad definitions. In recent years, the use
of monetary policy in its broad sense is getting popular, as it is more useful and practical

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B) MEANING OF FISCAL POLICY
Fiscal Policy is one more important component of overall economic policy.
Monetary policy deals with the changes in demand for and supply of money where as fiscal
policy is concerned with non-monetary instruments. Fiscal policy, by employing its
instruments secures the economic stabilization in developed economies and economic
growth in underdeveloped countries. Its instruments broadly consist of (i) taxes (ii) Public
Borrowing (iii) Public Expenditure.
The importance of fiscal policy as an instrument of economic development was first
envisaged by Keynes in his General Theory wherein he showed that the total national
income was an index of economic activity and brought out the relation between economic
activity and total spending. The direct and indirect effects of fiscal policy on aggregate
spending in the community were clearly established and as a result the budgetary policy of
the government as a weapon of economic control and development came into prominence.
But the Keynesian analysis of fiscal policy is, applicable to the advanced and industrialized
countries and it has little relevance to underdeveloped countries. Let now look at definitions
given by different economists.
According to Arthur Smithies, fiscal policy means ― a policy under which the government
uses its expenditure and revenue programs to produce desirable effects and to avoid
undesirable effects on the national income, production and employment‖ GK Shaw has
defined fiscal policy in these words, ―We define fiscal policy to encompass any decision to
change the level, composition or timing of government expenditure or to vary the burden,
structure or frequency of the tax payment‖. A skilful management of fiscal policy
instruments can go long way in maintaining economic stability and ensuring higher rates of
economic growth.

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HISTORY OF FISCAL POLICY
Fiscal policy initiated from the theory propounded by John Maynard Keynes, a British
economist popularly known as Keynesian economist. He states that government can
influence macroeconomic productivity levels by increasing or decreasing tax level and
public spending. The first monetary circular in Nigeria was issued in 1969 while a new
comprehensive banking decree was promulgated these a me year, to serve as guideline for
establishing and conducting banking business in Nigeria. Later, financial system was
comprehensively reviewed in 1979. The review called for an increase in banking
supervision and regulation to encourage specialization of financial institutions; a
comprehensive compound of training and manpowered development in the banking system,
and as part of the effort to improve the monetary management function of CBN, all
financial institutions were required to make return on financial statistics to the CBN. The
implementation of various recommendations took immediate effect. However, following
the collapse of the International Oil Marketing the mild 1981, the Nigerian economy, which
was mainly oil dependent, began to nosedive with negative consequences for the fiscal and
monetary system.
Apart from the worsening economic condition in the 1980s, there was political in
stability in addition to weak socio-cultural relations. By the end of 1985, it became an
imperative evident that the economy had to beer structure din order to overcome
monumental problems such as those posed by slow economic growth, unemployment, the
debt burden and fundamental imbalance in the structure of production and consumption. In
response to this difficult circumstance, the Nigerian government undertook a structural
adjustment programmed (SAP) with respect to the economy. The financial system for
instance, was first to experience radical structural changes following the adoption of the
SAP in June 1986. It was aimed at restructuring the production base of the economy and
promoting non-inflationary economic growth. The federal ministry of finance advice the
federal government on its fiscal operation in collaborates with the central bank of Nigeria
on monetary matters. In 1991, the banks and other financial institution act (BOFID)
formally was promulgated to replace the CBN act of 1958 and the banking degree of
1969(including later amendments). The policy brought the non-banking financial

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intermediaries under the supervision of CBN on the debate that such institutions are
capable of influencing the monetary policy set and if not properly monitored can altered the
financial sector. Since then, the Nigeria banking system has evolved rapidly in a healthy,
competitive and regulative prospect till date.

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HISTORY OF MONETARY POLICY
Monetary policy is associated with interest rates and availabilility of credit. Instruments of
monetary policy have included short-term interest rates and bank reserves through the
monetary base. For many centuries there were only two forms of monetary policy: (i)
Decisions about coinage; (ii) Decisions to print paper money to create credit. Interest rates,
while now thought of as part of monetary authority, were not generally coordinated with
the other forms of monetary policy during this time. Monetary policy was seen as an
executive decision, and was generally in the hands of the authority with seignior age, or the
power to coin. With the advent of larger trading networks came the ability to set the price
between gold and silver, and the price of the local currency to foreign currencies. This
official price could be enforced by law, even if it varied from the market price.
Paper money called "jiaozi" originated from promissory notes in 7th century China. Jiaozi
did not replace metallic currency, and were used alongside the copper coins. The successive
Yuan Dynasty was the first government to use paper currency as the predominant
circulating medium. In the later course of the dynasty, facing massive shortages of specie to
fund war and their rule in China, they began printing paper money without restrictions,
resulting in hyperinflation.
With the creation of the Bank of England in 1694, which acquired the responsibility to print
notes and back them with gold, the idea of monetary policy as independent of executive
action began to be established. The goal of monetary policy was to maintain the value of
the coinage, print notes which would trade at par to specie, and prevent coins from leaving
circulation. The establishment of central banks by industrializing nations was associated
then with the desire to maintain the nation's peg to the gold standard, and to trade in a
narrow band with other gold-backed currencies. To accomplish this end, central banks as
part of the gold standard began setting the interest rates that they charged, both their own
borrowers, and other banks who required liquidity. The maintenance of a gold standard
required almost monthly adjustments of interest rates.
During the 1870–1920 period, the industrialized nations set up central banking systems,
with one of the last being the Federal Reserve in 1913. By this point the role of the central
bank as the "lender of last resort" was understood. It was also increasingly understood that
interest rates had an effect on the entire economy, in no small part because of the marginal

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revolution in economics, which demonstrated how people would change a decision based
on a change in the economic trade-offs.
Monetarist economists long contended that the money-supply growth could affect the
macro economy. These included Milton Friedman who early in his career advocated that
government budget deficits during recessions be financed in equal amount by money
creation to help to stimulate aggregate demand for output. Later he advocated simply
increasing the monetary supply at a low, constant rate, as the best way of maintaining low
inflation and stable output growth. However, when U.S. Federal Reserve Chairman Paul
Volcker tried this policy, starting in October 1979, it was found to be impractical, because
of the highly unstable relationship between monetary aggregates and other macroeconomic
variables. Even Milton Friedman acknowledged that money supply targeting was less
successful than he had hoped, in an interview with the Financial Times on June 7, 2003.
Therefore, monetary decisions today take into account a wider range of factors, such as:
short term interest rates;
long term interest rates;
velocity of money through the economy;
exchange rates;
credit quality;
bonds and equities (corporate ownership and debt);
government versus private sector spending/savings;
international capital flows of money on large scales;
financial derivatives such as options, swaps, futures contracts, etc.
A small but vocal group of people, primarily libertarians and Constitutionalists advocate for
a return to the gold standard (the elimination of the dollar's fiat currency status and even of
the Federal Reserve Bank). Their argument is basically that monetary policy is fraught with
risk and these risks will result in drastic harm to the populace should monetary policy fail.
Others[who?]
see another problem with our current monetary policy. The problem for them is
not that our money has nothing physical to define its value, but that fractional reserve
lending of that money as a debt to the recipient, rather than a credit, causes all but a small
proportion of society (including all governments) to be perpetually in debt.

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In fact, many economists disagree with returning to a gold standard. They argue that doing
so would drastically limit the money supply, and throw away 100 years of advancement in
monetary policy. The sometimes complex financial transactions that make big business
(especially international business) easier and safer would be much more difficult if not
impossible. Moreover, shifting risk to different people/companies that specialize in
monitoring and using risk can turn any financial risk into a known dollar amount and
therefore make business predictable and more profitable for everyone involved. Some have
claimed that these arguments lost credibility in the global financial crisis of 2008–2009.
Trends in central banking
The central bank influences interest rates by expanding or contracting the monetary base,
which consists of currency in circulation and banks' reserves on deposit at the central bank.
The primary way that the central bank can affect the monetary base is by open market
operations or sales and purchases of second hand government debt, or by changing the
reserve requirements. If the central bank wishes to lower interest rates, it purchases
government debt, thereby increasing the amount of cash in circulation or crediting banks'
reserve accounts. Alternatively, it can lower the interest rate on discounts or overdrafts
(loans to banks secured by suitable collateral, specified by the central bank). If the interest
rate on such transactions is sufficiently low, commercial banks can borrow from the central
bank to meet reserve requirements and use the additional liquidity to expand their balance
sheets, increasing the credit available to the economy. Lowering reserve requirements has a
similar effect, freeing up funds for banks to increase loans or buy other profitable assets.
A central bank can only operate a truly independent monetary policy when the exchange
rate is floating.[18]
If the exchange rate is pegged or managed in any way, the central bank
will have to purchase or sell foreign exchange. These transactions in foreign exchange will
have an effect on the monetary base analogous to open market purchases and sales of
government debt; if the central bank buys foreign exchange, the monetary base expands,
and vice versa. But even in the case of a pure floating exchange rate, central banks and
monetary authorities can at best "lean against the wind" in a world where capital is mobile.
Accordingly, the management of the exchange rate will influence domestic monetary
conditions. To maintain its monetary policy target, the central bank will have to sterilize or
offset its foreign exchange operations. For example, if a central bank buys foreign

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exchange (to counteract appreciation of the exchange rate), base money will increase.
Therefore, to sterilize that increase, the central bank must also sell government debt to
contract the monetary base by an equal amount. It follows that turbulent activity in foreign
exchange markets can cause a central bank to lose control of domestic monetary policy
when it is also managing the exchange rate.
In the 1980s, many economists which argues that central bank monetary policy aggravates
the business cycle, creating malinvestment and maladjustments in the economy which then
cause downcycle corrections, but most economists fall into either the Keynesian or
neoclassical camps on this issue.
Developing countries
Developing countries may have problems establishing an effective operating monetary
policy. The primary difficulty is that few developing countries have deep markets in
government debt. The matter is further complicated by the difficulties in forecasting money
demand and fiscal pressure to levy the inflation tax by expanding the monetary base
rapidly. In general, the central banks in many developing countries have poor records in
managing monetary policy. This is often because the monetary authority in a developing
country is not independent of government, so good monetary policy takes a backseat to the
political desires of the government or are used to pursue other non-monetary goals. For this
and other reasons, developing countries that want to establish credible monetary policy may
institute a currency board or adopt dollarization. Such forms of monetary institutions thus
essentially tie the hands of the government from interference and, it is hoped, that such
policies will import the monetary policy of the anchor nation.
Recent attempts at liberalizing and reforming financial markets (particularly the
recapitalization of banks and other financial institutions in Nigeria and elsewhere) are
gradually providing the latitude required to implement monetary policy frameworks by the
relevant central banks.

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OBJECTIVES OF MONETARY POLICY:
The objectives of monetary policy have been varying from time to time depending upon the
nature of problems facing the countries and the general economic policy pursued by them.
The main objectives are: (a) Exchange Stability (b) Price Stability (c) Neutrality of Money
(d) Full-Employment (e) Economic Growth (f) Balance of Payments equilibrium. Some
times these objectives are mutually incompatible and the monetary authority has to make a
choice on the basis of priorities. For instance, the objective of maintaining exchange rate
stability may come in conflict with the objective of maintaining internal price stability;
Let us now see objectives of monetary policy in detail :-
1. Rapid Economic Growth: It is the most important objective of a monetary policy.
The monetary policy can influence economic growth by controlling real interest rate
and its resultant impact on the investment. If the RBI opts for a cheap or easy credit
policy by reducing interest rates, the investment level in the economy can be
encouraged. This increased investment can speed up economic growth. Faster
economic growth is possible if the monetary policy succeeds in maintaining income
and price stability.
2. Price Stability: All the economics suffer from inflation and deflation. It can also be
called as Price Instability. Both inflation are harmful to the economy. Thus, the
monetary policy having an objective of price stability tries to keep the value of
money stable. It helps in reducing the income and wealth inequalities. When the
economy suffers from recession the monetary policy should be an 'easy money
policy' but when there is inflationary situation there should be a 'dear money policy'.
3. Exchange Rate Stability: Exchange rate is the price of a home currency expressed
in terms of any foreign currency. If this exchange rate is very volatile leading to
frequent ups and downs in the exchange rate, the international community might
lose confidence in our economy. The monetary policy aims at maintaining the
relative stability in the exchange rate. The RBI by altering the foreign exchange
reserves tries to influence the demand for foreign exchange and tries to maintain the
exchange rate stability.
4. Balance of Payments (BOP) Equilibrium: Many developing countries like India
suffers from the Disequilibrium in the BOP. The Reserve Bank of India through its
monetary policy tries to maintain equilibrium in the balance of payments. The BOP

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has two aspects i.e. the 'BOP Surplus' and the 'BOP Deficit'. The former reflects an
excess money supply in the domestic economy, while the later stands for stringency
of money. If the monetary policy succeeds in maintaining monetary equilibrium,
then the BOP equilibrium can be achieved.
5. Full Employment: The concept of full employment was much discussed after
Keynes's publication of the "General Theory" in 1936. It refers to absence of
involuntary unemployment. In simple words 'Full Employment' stands for a
situation in which everybody who wants jobs get jobs. However it does not mean
that there is a Zero unemployment. In that senses the full employment is never full.
Monetary policy can be used for achieving full employment. If the monetary policy
is expansionary then credit supply can be encouraged. It could help in creating more
jobs in different sector of the economy.
6. Neutrality of Money: Economist such as Wicksted, Robertson has always
considered money as a passive factor. According to them, money should play only a
role of medium of exchange and not more than that. Therefore, the monetary policy
should regulate the supply of money. The change in money supply creates monetary
disequilibrium. Thus monetary policy has to regulate the supply of money and
neutralize the effect of money expansion. However this objective of a monetary
policy is always criticized on the ground that if money supply is kept constant then
it would be difficult to attain price stability.
7. Equal Income Distribution: Many economists used to justify the role of the fiscal
policy is maintaining economic equality. However in resent years economists have
given the opinion that the monetary policy can help and play a supplementary role
in attainting an economic equality. monetary policy can make special provisions for
the neglect supply such as agriculture, small-scale industries, village industries, etc.
and provide them with cheaper credit for longer term. This can prove fruitful for
these sectors to come up. Thus in recent period, monetary policy can help in
reducing economic inequalities among different sections of society.

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OBJECTIVES OF FISCAL POLICY
Objectives of fiscal policy are as follows (i) Securing the most efficient and rational
allocation of economic resources (ii) Accelerating the rate of capital formation (iii)
Controlling inflation (iv) Securing equitable distribution of income and wealth (v)Attaining
and maintaining full employment.
1. Development by effective Mobilisation of Resources
The principal objective of fiscal policy is to ensure rapid economic growth and
development. This objective of economic growth and development can be achieved by
Mobilisation of Financial Resources. The central and the state governments in India have
used fiscal policy to mobilise resources.
The financial resources can be mobilized by :-
1. Taxation : Through effective fiscal policies, the government aims to mobilise resources
by way of direct taxes as well as indirect taxes because most important source of
resource mobilisation in India is taxation.
2. Public Savings : The resources can be mobilised through public savings by reducing
government expenditure and increasing surpluses of public sector enterprises.
3. Private Savings : Through effective fiscal measures such as tax benefits, the
government can raise resources from private sector and households. Resources can be
mobilised through government borrowings by ways of treasury bills, issue of
government bonds, etc., loans from domestic and foreign parties and by deficit
financing.
2. Efficient allocation of Financial Resources:
The central and state governments have tried to make efficient allocation of financial
resources. These resources are allocated for Development Activities which includes
expenditure on railways, infrastructure, etc. While Non-development Activities includes
expenditure on defence, interest payments, subsidies, etc.
3. Reduction in inequalities of Income and Wealth: Fiscal policy aims at achieving
equity or social justice by reducing income inequalities among different sections of the

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society. The direct taxes such as income tax are charged more on the rich people as
compared to lower income groups. Indirect taxes are also more in the case of semi-luxury
and luxury items, which are mostly consumed by the upper middle class and the upper
class. The government invests a significant proportion of its tax revenue in the
implementation of Poverty Alleviation Programmes to improve the conditions of poor
people in society.
4. Price Stability and Control of Inflation:One of the main objective of fiscal policy is to
control inflation and stabilize price. Therefore, the government always aims to control the
inflation by Reducing fiscal deficits, introducing tax savings schemes, Productive use of
financial resources, etc.
5. Employment Generation:The government is making every possible effort to increase
employment in the country through effective fiscal measure. Investment in infrastructure
has resulted in direct and indirect employment. Lower taxes and duties on small-scale
industrial (SSI) units encourage more investment and consequently generates more
employment. Various rural employment programmes have been undertaken by the
Government of India to solve problems in rural areas. Similarly, self employment scheme is
taken to provide employment to technically qualified persons in the urban areas.
6. Balanced Regional Development: Another main objective of the fiscal policy is to
bring about a balanced regional development. There are various incentives from the
government for setting up projects in backward areas such as Cash subsidy, Concession in
taxes and duties in the form of tax holidays, Finance at concessional interest rates, etc.
7. Reducing the Deficit in the Balance of Payment: Fiscal policy attempts to encourage
more exports by way of fiscal measures like Exemption of income tax on export earnings,
Exemption of central excise duties and customs, Exemption of sales tax and octroi, etc.
The foreign exchange is also conserved by Providing fiscal benefits to import substitute
industries, Imposing customs duties on imports, etc.
The foreign exchange earned by way of exports and saved by way of import substitutes
helps to solve balance of payments problem. In this way adverse balance of payment can be
corrected either by imposing duties on imports or by giving subsidies to export.

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8. Capital Formation:The objective of fiscal policy in India is also to increase the rate of
capital formation so as to accelerate the rate of economic growth. An underdeveloped
country is trapped in vicious (danger) circle of poverty mainly on account of capital
deficiency. In order to increase the rate of capital formation, the fiscal policy must be
efficiently designed to encourage savings and discourage and reduce spending.
9. Increasing National Income: The fiscal policy aims to increase the national income of a
country. This is because fiscal policy facilitates the capital formation. This results in
economic growth, which in turn increases the GDP, per capita income and national income
of the country.
10. Development of Infrastructure: Government has placed emphasis on the
infrastructure development for the purpose of achieving economic growth. The fiscal policy
measure such as taxation generates revenue to the government. A part of the government's
revenue is invested in the infrastructure development. Due to this, all sectors of the
economy get a boost.

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CHAPTER-2
REVIEW OF LITERATURE MONETARY POLICY
Monetary policy rests on the relationship between the rates of interest in an economy, that
is, the price at which money can be borrowed, and the total supply of money. Monetary
policy uses a variety of tools to control one or both of these, to influence outcomes like
economic growth, inflation, exchange rates with other currencies and unemployment.
Where currency is under a monopoly of issuance, or where there is a regulated system of
issuing currency through banks which are tied to a central bank, the monetary authority has
the ability to alter the money supply and thus influence the interest rate (to achieve policy
goals). The beginning of monetary policy as such comes from the late 19th century, where
it was used to maintain the gold standard.
A policy is referred to as contractionary if it reduces the size of the money supply or
increases it only slowly, or if it raises the interest rate. An expansionary policy increases the
size of the money supply more rapidly, or decreases the interest rate. Furthermore,
monetary policies are described as follows: accommodative, if the interest rate set by the
central monetary authority is intended to create economic growth; neutral, if it is intended
neither to create growth nor combat inflation; or tight if intended to reduce inflation.
There are several monetary policy tools available to achieve these ends: increasing interest
rates by fiat; reducing the monetary base; and increasing reserve requirements. All have the
effect of contracting the money supply; and, if reversed, expand the money supply. Since
the 1970s, monetary policy has generally been formed separately from fiscal policy. Even
prior to the 1970s, the Breton Woods system still ensured that most nations would form the
two policies separately.
Within almost all modern nations, special institutions (such as the Federal Reserve System
in the United States, the Bank of England, the European Central Bank, the People's Bank of
China, and the Bank of Japan) exist which have the task of executing the monetary policy
and often independently of the executive. In general, these institutions are called central
banks and often have other responsibilities such as supervising the smooth operation of the
financial system.

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The primary tool of monetary policy is open market operations. This entails managing the
quantity of money in circulation through the buying and selling of various financial
instruments, such as treasury bills, company bonds, or foreign currencies. All of these
purchases or sales result in more or less base currency entering or leaving market
circulation.
Usually, the short term goal of open market operations is to achieve a specific short term
interest rate target. In other instances, monetary policy might instead entail the targeting of
a specific exchange rate relative to some foreign currency or else relative to gold. For
example, in the case of the USA the Federal Reserve targets the federal funds rate, the rate
at which member banks lend to one another overnight; however, the monetary policy of
China is to target the exchange rate between the Chinese renminbi and a basket of foreign
currencies.
The other primary means of conducting monetary policy include: (i) Discount window
lending (lender of last resort); (ii) Fractional deposit lending (changes in the reserve
requirement); (iii) Moral suasion (cajoling certain market players to achieve specified
outcomes); (iv) "Open mouth operations" (talking monetary policy with the market).
Theory
Monetary policy is the process by which the government, central bank, or monetary
authority of a country controls (i) the supply of money, (ii) availability of money, and (iii)
cost of money or rate of interest to attain a set of objectives oriented towards the growth
and stability of the economy.[1] Monetary theory provides insight into how to craft optimal
monetary policy.
Monetary policy rests on the relationship between the rates of interest in an economy, that
is the price at which money can be borrowed, and the total supply of money. Monetary
policy uses a variety of tools to control one or both of these, to influence outcomes like
economic growth, inflation, exchange rates with other currencies and unemployment.
Where currency is under a monopoly of issuance, or where there is a regulated system of
issuing currency through banks which are tied to a central bank, the monetary authority has
the ability to alter the money supply and thus influence the interest rate (to achieve policy
goals).

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REVIEW OF LITERATURE ON COUNTERCYCLICAL
FISCAL POLICY
There are a number of studies that have examined budgetary policies of the Government in
the context of their responsiveness to cyclical fluctuations in the economy. Even though, as
is widely believed, there is greater importance of such fiscal stance in developing countries,
the stabilizing policies carried out by Western countries have also received considerable
attention.
The present review of literature is essential in the context of the FRBM Act, which has
been enacted not only by many of the states but also the Central Government of India. The
issue of FRBM becomes vital since it is very much essential for the Government to fiscally
intervene during the time of economic downturns, whereas the enactment of the Act itself
binds the Government not to increase its expenditure in a productive manner during such
times. There lies the contradiction, which leads one to go for a review of literature.
Anybody who has studied Economics can always agree that there exists business cycle in a
capitalist economy, and so there exist upturns and downturns. FRBM Act is always good
when a capitalist economy is undergoing through rapid economic progress, so that
productive Government expenditure do not crowd out private investment. However, some
economists may claim that fiscal intervention may not be necessary during bad times
because of the existence of ―automatic stabilizers‖. Hence, the enactment of FRBM Act is
justified. But there is also the requirement for doing a study, which is empirical in nature so
that one knows whether economic intervention by the Government is needed or not during
Auerbach (2002) finds that in the recent years, US discretionary fiscal policy appears to
have become more active in response to both cyclical conditions and a simple measure of
budget balance. Budgetary pressure may weaken the efficacy of expansionary fiscal policy,
Auerbach (2002) argues. Fiscal policy, which is contractionary in nature, might have a
positive impact on output. The paper by Auerbach (2002) says that automatic stabilizers
embedded in the fiscal system have little net change since the 1960s and have contributed
to cushioning cyclical fluctuations. The tax revenues itself is very much sensitive to the
economic cycle. Auerbach (2002) finds that employment surplus has fallen in response to a
rise in the Gross Domestic Product (GDP) gap, consistent with the use of discretionary
countercyclical fiscal policy. Auerbach‘s (2002) result suggests a recent increase in the

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responsiveness of discretionary spending to the budget surplus, with this relationship being
statistically significant since 1993. Fiscal policy has been responsive both to cyclical
factors and conditions of fiscal balance during recent decades. One method of measuring,
according to Auerbach‘s (2002), the strength of automatic stabilizers is related to the gap
between the full-employment surplus, and the unadjusted surplus to the contemporaneous
gap between GDP and full employment GDP. Auerbach‘s (2002) paper show that
discretionary fiscal policy‘s overall impact was minimal compared to that of monetary
policy. Automatic stabilizers are directly tied to output fluctuation.
The role of current and tax provisions and expectations has been described by Auerbach
(2002) using the standard Hall-Jorgenson user cost of capital, which provides a measure of
the required gross, before-tax return to measure of the incentive to use capital in
production. Auerbach (2002) has used the data from CBO forecast revisions, which are
available since summer, 1984, as the pattern of semiannual forecast begins with the winter,
1984 Budget Outlook. For each observation, Auerbach (2002) measures the policy changes
with respect to revenues, expenditures, or their difference—the surplus—as the discounted
sum of policy changes adopted during the interval for the current and subsequent five fiscal
years (relative to each year‘s corresponding measure of potential GDP), with the six
weights normalized to sum to 1. Auerbach (2002) has also done calculation on the basis of
NBER TAXSIM model using a ‗tax calculator‘ in order to estimate the impact on tax
liability of changes in tax-return components of income and deductions.
capital and hence a Buti‘s (2001) study find that it takes time, as well, to pass the fiscal
measures through the national Parliaments and it takes time for the economy to respond.
Hence, once decided, the fiscal policy measures can rarely be adjusted to the changing
economic circumstances.
Moreover, there are always political constraints: it tends to be much easier for governments
to ease fiscal policy than to tighten and once the measure is taken it tends to become
irreversible.

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LIMITATIONS OF MONETARY POLICY:
1. There exist a Non-Monetized Sector
In many developing countries, there is an existence of non-monetized economy in large
extent. People live in rural areas where many of the transactions are of the barter type and
not monetary type. Similarly, due to non-monetized sector the progress of commercial
banks is not up to the mark. This creates a major bottleneck in the implementation of the
monetary policy.
2. Excess Non-Banking Financial Institutions (NBFI)
As the economy launch itself into a higher orbit of economic growth and development, the
financial sector comes up with great speed. As a result many Non-Banking Financial
Institutions (NBFIs) come up. These NBFIs also provide credit in the economy. However,
the NBFIs do not come under the purview of a monetary policy and thus nullify the effect
of a monetary policy.
3. Existence of Unorganized Financial Markets
The financial markets help in implementing the monetary policy. In many developing
countries the financial markets especially the money markets are of an unorganized nature
and in backward conditions. In many places people like money lenders, traders, and
businessman actively take part in money lending. But unfortunately they do not come under
the purview of a monetary policy and creates hurdle in the success of a monetary policy.
4. Higher Liquidity Hinders Monetary Policy
In rapidly growing economy the deposit base of many commercial banks is expanded. This
creates excess liquidity in the system. Under this circumstances even if the monetary policy
increases the CRR or SLR, it dose not deter commercial banks from credit creation. So the
existence of excess liquidity due to high deposit base is a hindrance in the way of
successful monetary policy.

21
5. Money Not Appearing in an Economy
Large percentage of money never come in the mainstream economy. Rich people, traders,
businessmen and other people prefer to spend rather than to deposit money in the bank.
This shadow money is used for buying precious metals like gold, silver, ornaments, land
and in speculation. This type of lavish spending give rise to inflationary trend in
mainstream economy and the monetary policy fails to control it.
6. Time Lag Affects Success of Monetary Policy
The success of the monetary policy depends on timely implementation of it. However, in
many cases unnecessary delay is found in implementation of the monetary policy. Or many
times timely directives are not issued by the central bank, then the impact of the monetary
policy is wiped out.

22
LIMITATIONS OF FISCAL POLICY:
1.Lack of Elasticity: - In countries like India tax system is not that elastic as it is supposed
to be. Moreover in these economies because of huge tax evasion, it is difficult to earn
revenue from taxes. The spread of tax is very few.
2. Non Monetised Sector: - Although each and every activity is now awarded in terms of
money, but still a major part of economy of UDC's like India is not monetised. In this part
fiscal policy remains unaffected.
3. Inadequate Statistics: - In the countries like India adequate and reliable date is not
available. Because of non-availability of reliable and accurate data, the area of fiscal policy
remains unaffected.
4. Illiteracy: - Most of the population of India is either illiterate or not in a position to
understand economic policies and is implications, that is why they are not able to evaluate
the importance of fiscal policy and, therefore, they also try to evade taxes.
5. Limited Sector: - Fiscal policy only affects a few sectors of the economy. Most of the
sectors remain untouched e.g. burden of taxes on salaried person whereas big businessmen
hardly pay any taxes in spite of high income levels.
6. Delay in decision: - Fiscal policy decision needs approval by the Government. A lot of
time required for approvals, that is why decisions are not taken at proper time.
7. Limitations regarding full employment: - As a result of fiscal policy in connection
with full employment wage rate increases. Increases in wage rate results into increase in
prices instead of increase in production. Employment multiplier decreases and desired
increase in employment does not take place. Structural unemployment cannot be tackled by
fiscal policy.
8. Defective Tax Structure: - The country been relying more on indirect taxes ultimately
affecting poor persons. Contribution to direct taxes has been declining and that of indirect
taxes rising.

23
9. Inflation: - As a result of increase of public expenditure on non-development heads and
deficit financing pull inflation has taken place. Also high rate of indirect taxes has resulted
in cost push inflation. High rate of direct taxes and increase of black money in the country
has given rise to parallel economy and increase in inflation.
10. Huge investment with negative return in public sector: - Huge investments in public
sector have become sunk money now because of failure of public sector. Investment of
Rs.2,04,054crore was made in public sector enterprises in 1998 and Rs.3,03,400 crore in
2001. Return on this investment has been very low. Also takeover of sick textile mills by
government has further increased public expenditure. Huge amount has to be spent to keep
such undertakings going thus making the resources of country scarce.

24
ROLE OF MONETARY POLICY IN ECONOMIC
DEVELOPMENT:
The role of monetary policy in economic development may be discussed under the
following lines of approach:
Appropriate Adjustment between Demand for and Supply of money
Price Stability
Credit Control
Creation and Expansion of Financial Institutions
Suitable Interest Rate Structure
Debt Management
Monetary policy can play a vital role in the economic development of underdeveloped
countries by minimizing fluctuations in prices and general economic activity by achieving
an appropriate balance between the demand for money and supply of money. Because,
economic development result in increase in more demand for money and it makes
imperative for the monetary authority to increase the money supply but either more or less
money supply than the requirement result in fluctuations in an economy. Therefore, the gist
of the argument is that a proper control upon the supply of money will prevent economic
fluctuations and pave the way for rapid development of underdeveloped economies.
In the process of economic development, it is unavoidable an increase in prices. Therefore
it is imperative for the monetary authority for maintenance of stability in the domestic level
of prices and exchange rates. The inflationary trend in price negatively affects the savings
and diverts investment into unproductive channels. It is the duty to have a vigil by the
monetary authority not only to regulate but also should keep constant heck on the direction
of money flow in turn to control price rise. The same inflationary trend will also adversely
affect international trade and the foreign exchange earnings which otherwise could help in
the development of the country. Thus, monetary policy should adopt such policy, which
will check inflation and frequent devaluation of the currency.

25
Monetary authority should also employ quantitative and qualitative credit control tools for
the control of inflation, correction of adverse balance of payments and help the process of
economic development. Not only that, with these instruments, it can influence and shape
the character and pattern of investment and production, in particular selective credit control,
unlike quantitative credit control, makes a discrimination between essential and non-
essential uses of bank credit and help the funds to flow into desirable and uses without
affecting the economy as a whole. This will quicken the pace of economic development.
The process of economic development can speed up by establishing more and more
financial institutions by developing financial system. These institutions are in less number
in underdeveloped economies, therefore, it is difficult to mobilize the savings from the
public effectively for economic development and consequently economic growth rate is
very low. Monetary authority to extend the sphere of the monetary sector with the
expansion of co-operative banking sector to meet the credit needs of ruralites and cut the
tentacles of non-magnetized sector in rural areas.
There are two subcomponents of monetary policy: cheap and dear money policy. Cheap
money policy in other words availability of funds at lower rates of interest to stimulates
investment both public and private. Thus, a policy of low interest rates serves as an
incentive to investment for economic development. But there is harm if these funds are
diverted for hoarding and stockpiling and for other speculative purposes, thus monetary
authority should be checked through selective credit controls and thereby directing
investment into desirable channels. In contrary to low rates of interest policy, there are
economists who suggest a policy of high interest rates to control inflationary conditions.
Further they stated that it would stimulate savings and thus increase the supply of
investable resources; it would secure the allocation of scarce resources into most productive
uses. Therefore, keeping in view the conditions in an economy, countries should be more
pragmatic in their approach and must evolve differentiated interest rate policy, which
ensure rapid pace of economic development.

26
ROLE OF FISCAL POLICY IN ECONOMIC
DEVELOPMENT:
K Kurihara regards fiscal policy as a ―desiderate for underdeveloped countries lacking in
private initiative, private voluntary saving and private innovation‖. He discusses the fiscal
policy of government as an additional saver, an investor and an income redistributors. He
observes as par as underdeveloped economy is concerned, budgetary surplus is the relevant
position to be achieved and maintained. As an additional investor, government can increase
the productive capacity of the economy and secure an accelerated rate of economic growth
by changing the pattern of investment and laying emphasis on capacity creating rather than
on income-generating aspects. As an innovator, the government should spend on research
and experimentation and stimulate innovations and new techniques of production. As an
income redistributors and for that fiscal measures can go a long way in reducing economic
inequalities. In the words of Nurkse, fiscal policy assumes a new significance in he face of
the problem of capital formation in underdeveloped countries‖
The fiscal policy should be construed as to secure full employment conditions and
economic growth at rapid rate. The integration of the government budgets with the nation‘s
economy budgets can go a long way for the attainment of the objectives of rapid economic
development and creation of full employment opportunities. We now proceed to discuss the
role of fiscal policy instruments role in economic development
Taxation: Of the important sources of public revenue taxation is the most important.
Through taxation, governments are collecting from 10- 30 percent levels to the national
income in developed countries. Shortage of financial resources is the main obstacle in the
way of economic development of the underdeveloped countries. There are certain forces
operating in these countries, which increase consumption and reduce savings. The first
among them is the population pressure. Besides, the high incomes groups spend much
of their incomes on conspicuous consumption and their propensity to consume is
further reinforced by the ‗demonstration effect‘ Still worse, a large part of the meager
savings is dissipated in unproductive channels like real estate, hoarding, gold, jewellery,
speculation, etc the taxation measures can be employed effectively to divert savings of the
people into productive channels. In this connection, Report of the Taxation Enquiry

27
Commission, Govt of India, observes, ―A tax system which on the whole, promotes capital
formation in its two aspects of saving and investment fulfills an essential desideratum.
Public Borrowing: There is a limit to which taxation can be resorted for resource
mobilization. If the taxes are excessive, they will adversely affect people‘s desire and
ability to work, save and invest. This will obviously retard the paced of economic
development. To avoid such a situation, public borrowing may cover the gap in resources
required. It will not adversely affect people‘s desire to work, save and invest as lending is
voluntary n the lenders not only get back the amount lent but also earn interest on it.
Further, public borrowing may add to the incentives of the people to save and invest moreas
he lure of earning more interest on lending is there. Public borrowing has its own
limitations. The general masses are poor and their propensity to consume is high and hence
they have no lending capacity. The rich generally do not like to lend to the government but
instead divert their investive resources into speculative channels as they can earn more
from there. Absence of organized money and capital markets are some of the other
obstacles in the way of public borrowing program. However, government has to do efforts
to compulsory borrowing for economic development. But it may be noted that no
democratic government can rely on forced loans except for a short period and for certain
specified projects. Ultimately, it is the voluntary lending by the people that matters and the
government must be prepared to increase its domestic borrowing when the incomes and
savings of the people increase as a result of economic and make public borrowing and
important tool of resource mobilization.
Public Expenditure: Public expenditure is one of the important weapons in the hands of
the state to secure economic development of underdeveloped economies. Initially for
economic development, infrastructure facilities have to be provided. For which,
government initiation is essential condition. Therefore, government has to spent huge
amount on its development to pave the way to private entrepreneur to start key industries
and also agro- based industries.

28
TYPES OF MONETORY POLICY
In practice, to implement any type of monetary policy the main tool used is modifying the
amount of base money in circulation. The monetary authority does this by buying or selling
financial assets (usually government obligations). These open market operations change
either the amount of money or its liquidity (if less liquid forms of money are bought or
sold). The multiplier effect of fractional reserve banking amplifies the effects of these
actions.
Constant market transactions by the monetary authority modify the supply of currency and
this impacts other market variables such as short term interest rates and the exchange rate.
The distinction between the various types of monetary policy lies primarily with the set of
instruments and target variables that are used by the monetary authority to achieve their
goals.
The different types of policy are also called monetary regimes, in parallel to exchange rate
regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results
in a relatively fixed regime towards the currency of other countries on the gold standard
and a floating regime towards those that are not. Targeting inflation, the price level or other
monetary aggregates implies floating exchange rate unless the management of the relevant
foreign currencies is tracking exactly the same variables (such as a harmonized consumer
price index).
1.Inflation targeting
Under this policy approach the target is to keep inflation, under a particular definition such
as Consumer Price Index, within a desired range.
The inflation target is achieved through periodic adjustments to the Central Bank interest
rate target. The interest rate used is generally the interbank rate at which banks lend to each
other overnight for cash flow purposes. Depending on the country this particular interest
rate might be called the cash rate or something similar.The interest rate target is maintained
for a specific duration using open market operations. Typically the duration that the interest
rate target is kept constant will vary between months and years. This interest rate target is
usually reviewed on a monthly or quarterly basis by a policy committee.

29
Changes to the interest rate target are made in response to various market indicators in an
attempt to forecast economic trends and in so doing keep the market on track towards
achieving the defined inflation target. For example, one simple method of inflation
targeting called the Taylor rule adjusts the interest rate in response to changes in the
inflation rate and the output gap. The rule was proposed by John B. Taylor of Stanford
University. The inflation targeting approach to monetary policy approach was pioneered in
New Zealand. It is currently used in Australia, Brazil, Canada, Chile, Colombia, the Czech
Republic, Hungary, New Zealand, Norway, Iceland, India, Philippines, Poland, Sweden,
South Africa, Turkey, and the United Kingdom.
2.Price level targeting
Price level targeting is similar to inflation targeting except that CPI growth in one year over
or under the long term price level target is offset in subsequent years such that a targeted
price-level is reached over time, e.g. five years, giving more certainty about future price
increases to consumers. Under inflation targeting what happened in the immediate past
years is not taken into account or adjusted for in the current and future years.
Uncertainty in price levels can create uncertainty around price and wage setting activity for
firms and workers, and undermines any information that can be gained from relative prices,
as it is more difficult for firms to determine if a change in the price of a good or service is
because of inflation or other factors, such as an increase in the efficiency of factors of
production, if inflation is high and volatile. An increase in inflation also leads to a decrease
in the demand for money, as it reduces the incentive to hold money and increases
transaction costs and shoe leather costs.
3.Monetary aggregates
In the 1980s, several countries used an approach based on a constant growth in the money
supply. This approach was refined to include different classes of money and credit (M0, M1
etc.). In the USA this approach to monetary policy was discontinued with the selection of
Alan Greenspan as Fed Chairman.
This approach is also sometimes called monetarism.

30
While most monetary policy focuses on a price signal of one form or another, this approach
is focused on monetary quantities.
4.Fixed exchange rate
This policy is based on maintaining a fixed exchange rate with a foreign currency. There
are varying degrees of fixed exchange rates, which can be ranked in relation to how rigid
the fixed exchange rate is with the anchor nation.Under a system of fiat fixed rates, the
local government or monetary authority declares a fixed exchange rate but does not actively
buy or sell currency to maintain the rate. Instead, the rate is enforced by non-convertibility
measures (e.g. capital controls, import/export licenses, etc.). In this case there is a black
market exchange rate where the currency trades at its market/unofficial rate.
Under a system of fixed-convertibility, currency is bought and sold by the central bank or
monetary authority on a daily basis to achieve the target exchange rate. This target rate may
be a fixed level or a fixed band within which the exchange rate may fluctuate until the
monetary authority intervenes to buy or sell as necessary to maintain the exchange rate
within the band. (In this case, the fixed exchange rate with a fixed level can be seen as a
special case of the fixed exchange rate with bands where the bands are set to zero.)
5.Gold standard
The gold standard is a system under which the price of the national currency is measured in
units of gold bars and is kept constant by the government's promise to buy or sell gold at a
fixed price in terms of the base currency. The gold standard might be regarded as a special
case of "fixed exchange rate" policy, or as a special type of commodity price level
targeting.The minimal gold standard would be a long-term commitment to tighten monetary
policy enough to prevent the price of gold from permanently rising above parity. A full
gold standard would be a commitment to sell unlimited amounts of gold at parity and
maintain a reserve of gold sufficient to redeem the entire monetary base.
Today this type of monetary policy is no longer used by any country, although the gold
standard was widely used across the world between the mid-19th century through 1971.Its
major advantages were simplicity and transparency. The gold standard was abandoned
during the Great Depression, as countries sought to reinvigorate their economies by

31
increasing their money supply. The Bretton Woods system, which was a modified gold
standard, replaced it in the aftermath of World War II. However, this system too broke
down during the Nixon shock of 1971.
The gold standard induces deflation, as the economy usually grows faster than the supply of
gold. When an economy grows faster than its money supply, the same amount of money is
used to execute a larger number of transactions. The only way to make this possible is to
lower the nominal cost of each transaction, which means that prices of goods and services
fall, and each unit of money increases in value. Absent precautionary measures, deflation
would tend to increase the ratio of the real value of nominal debts to physical assets over
time. For example, during deflation, nominal debt and the monthly nominal cost of a fixed-
rate home mortgage stays the same, even while the dollar value of the house falls, and the
value of the dollars required to pay the mortgage goes up. Mainstream economics considers
such deflation to be a major disadvantage of the gold standard. Unsustainable (i.e.
excessive) deflation can cause problems during recessions and financial crisis lengthening
the amount of time an economy spends in recession. William Jennings Bryan rose to
national prominence when he built his historic (though unsuccessful) 1896 presidential
campaign around the argument that deflation caused by the gold standard made it harder for
everyday citizens to start new businesses, expand their farms, or build new homes.
Policy of various nations
Bangladesh - Inflation targeting
Australia – Inflation targeting
Brazil – Inflation targeting
Canada – Inflation targeting
Chile – Inflation targeting
China – Monetary targeting and targets a currency basket
Czech Republic – Inflation targeting
Colombia – Inflation targeting
Hong Kong – Currency board (fixed to US dollar)
India – Multiple indicator approach
New Zealand – Inflation targeting
Norway – Inflation targeting

32
TYPES OF FISCAL POLICY
Fiscal policy is the deliberate adjustment of government spending, borrowing or taxation to
help achieve desirable economic objectives. It works by changing the level or composition
of aggregate demand (AD).
There are two types of fiscal policy, discretionary and automatic.
1. Discretionary policy refers to policies that are implemented through one-off policy
changes.
2. Automatic stabilisation, where the economy can be stabilised by processes called fiscal
drag and fiscal boost.
Central government borrowing
Government must borrow if its revenue is insufficient to pay for expenditure - a situation
called a fiscal deficit. Borrowing, which can be short term or long term, involves selling
government bonds or bills. Bonds are long term securities that pay a fixed rate of return
over a long period until maturity, and are bought by financial institutions looking for a safe
return. Treasury bills are issued into the money markets to help raise short term cash, and
last only 90 days, whereupon they are repaid.
Local government borrowing
If the revenue from the council tax and central government support is insufficient to meet
spending commitments, local authorities can also borrow by issuing bonds. Only around
25% of local authority spending is financed by local revenue raising, 75% coming from
central government and by borrowing. (Source: Local Government Association)
Public Sector Net Borrowing
If the borrowing requirements of both central and local government is combined, the
amount of borrowing required is called the public sector net borrowing (PSNB). The need
to borrow varies considerably with the business cycle.

33
During periods of economic growth, tax yields rise and spending on welfare payments fall,
pushing the public finances towards a surplus. During periods of economic slowdown, tax
yields fall and welfare payments rise, pushing the economy towards a fiscal deficit.
In 2009, the government introduced a new measure of public sector borrowing, called
Public Sector Net Borrowing Ex (PSNBEx). This measure excludes payments to the
financial sector to ease the credit crisis.
The Chancellor‘s golden rules for borrowing
The Chancellor‘s golden rules for sustainable investment are firstly, to balance the books
over a trade cycle, and secondly, only to borrow to fund capital projects, such as road
building.
Borrowing, and the financial crisis
According to the Institute for Fiscal Studies (IFS), the central government net borrowing
requirement in 2009, of approximately £150b, was almost double initial estimates. The
main reason for this overshoot was the rescue package for the banking sector, following the
global financial crisis.
This package included:
1. £37b for re-capitalisation of the main banks, RBS, Lloyds and HBOS.
2. £21b to the Bank of England to help refinance the financial services sector.
Fiscal deficits and the National Debt
Fiscal deficits occur when the revenue received by a government is less than spending
during a financial year. These deficits will create the need to borrow by selling government
securities - bills and bonds.

34
CHAPTER-3
SUMMARY AND CONCLUSION
The consensus assignment suggests that monetary policy, if it is unconstrained by zero
bound or other concerns, should look after business cycle stabilisation and inflation control,
and fiscal policy should focus on the control of government debt or deficits. Compared to a
fully optimal monetary-fiscal regime, fiscal policy is restricted to only focus on debt, and
monetary policy is restricted not to respond to debt. Research on monetary and fiscal policy
interactions has been dominated in the last 5-10 years by the convergence of two,
previously distinct literatures: studies of dynamic optimal taxation and New Keynesian
analysis. This paper has examined what this new research implies for the consensus
assignment.
The paper looked at various analyses of monetary and fiscal policy in sticky price
economies which imply that the costs of excluding fiscal policy from business cycle
stabilisation are very small. Large differences across the models used, particularly in terms
of the instruments employed and shocks considered rule out many explanations for this
result. Instead, we argue that the basic structure of New Keynesian models implies that
monetary policy dominates fiscal policy as a means of controlling inflation. This is the case
even when monetary policy cannot eliminate the inflationary consequence of shocks,
following cost push shocks for example. As a result, justifications of this aspect of the
conventional assignment do not need to appeal to political economy or institutional
constraints on fiscal actions.
At first sight the new literature also suggests that the costs of preventing monetary policy
from reacting to debt are small. However this may be predicated on a particular feature of
this literature, which is that under commitment it is optimal to let debt follow a random
walk, or adjust debt very gradually. As shocks to debt are largely accommodated in this
case, there is very little scope for monetary policy to control debt. However, there are a
number of reasons for also looking at cases where debt is required to return to its pre-shock
level more aggressively, which would be a feature of the time consistent policy for
example. In that situation, and if initial levels of debt are high, it may be that changes in
interest rates are an efficient method of controlling debt. Monetary policy can both
influence debt and stabilise inflation by exploiting the forward looking nature of

35
consumption and pricing behaviour. In this case, debt stabilisation biases or political
economy concerns related to deficit bias may be critical in justifying this half of the
consensus assignment.

36
REFRENCES:
BIBLIOGRAPHY
EPW (Economic & political Weekly).
Economics of global trade and finance(Johnson).
Michal waz (marvel publication).
WIBLOGRAPHY
www.wikipedia.com.
www.google.com.

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