Question

describe how the government uses monetary and fiscal policies to influence the economy. In your answer, be sure to provide clear definitions of what monetary and fiscal policies are and link these definitions to a discussion of the Federal Reserve System and the federal budget.

Answer 1

The government uses fiscal policies to influence the economy :  

1. 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.

2. Reducing the Deficit in the Balance of Payment. Fiscal policy main objective is to reducing the deficit in balance of payment.when import is more than export then situation is not favourable for economy and hence need treatment to make it balance.

3. 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.

4. 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.

5. 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.

6. Foreign Exehange Earnings. Fiscal policy attempts to encourage more exports by way of Fiscal Measures like, exemption of income tax on export earnings, exemption of sales tax and octroi, etc. Foreign exchange provides fiscal benefits to import substitute industries. The foreign exchange earned by way of exports and saved by way of import substitutes helps to solve balance of payments problem.

The government uses monetary policies to influence the economy :

1.Promotion of Exports and Food Procurement Operations. Monetary policy pays special attention in order to boost exports and facilitate the trade. It is an independent objective of monetary policy.

2. Desired Distribution of Credit. Monetary authority has control over the decisions regarding the allocation of credit to priority sector and small borrowers. This policy decides over the specified percentage of credit that is to be allocated to priority sector and small borrowers.

3. Equitable Distribution of Credit. The policy of Reserve Bank aims equitable distribution to all sectors of the economy and all social and economic class of people

4. To Promote Efficiency. It is another essential aspect where the central banks pay a lot of attention. It tries to increase the efficiency in the financial system and tries to incorporate structural changes such as deregulating interest rates, ease operational constraints in the credit delivery system, to introduce new money market instruments etc.

5. Reducing the Rigidity. RBI tries to bring about the flexibilities in the operations which provide a considerable autonomy. It encourages more competitive environment and diversification. It maintains its control over financial system whenever and wherever necessary to maintain the discipline and prudence in operations of the financial system.