UNIT – III NOTES

1. NATIONAL INCOME

Contents

• Introduction
• Concept of National Income
• Methods of measuring National Income
• Importance of measuring National Income
• Challenges in measuring National Income

National Income

National income measures the total value of goods & services produced within the
economy during the course of a year”

“The labour & capital of a country acting upon it’s natural resources produces annually a
certain amount of net aggregate of commodities, material and immaterial including services
of all kinds”

- Prof. Marshall

Concepts of National Income

▪ Gross Domestic Product

▪ Net Domestic Product
▪ Gross National Product
▪ Net National Product
▪ National Income at Factor cost
▪ Personal Income
▪ Disposable Personal Income
Gross Domestic Product (GDP)

“GDP is the aggregate money value of the all final value of the goods and services produced
in the domestic territory of a country during an financial year”

▪ GDP = Consumption Expenditure+ Investment Expenditure + Government Expenditure

Net Domestic Product (NDP)

“NDP refers to the market value of all final goods and services turned out in an economy
during a given period of time after making allowance for depreciation charges”

▪ NDP = GDP – Depreciation charges

Gross National Product (GNP)

“GNP is defined as the total market value of all final goods and services produced in a
country in an year’s time”

▪ GNP = GDP + X – M

X=Income earned by nationals abroad &

M=Income earned by foreigners in the given country

Net National Product (NNP)

“NNP is the market value of the net output of final goods and services produced by the
country during the relevant income period”

▪ NNP = GNP – Depreciation charges

▪ NNP = NDP + X - M

▪ NNP gives idea net increase in total production of the country

National Income at Factor cost

“NI at factor cost refers to all incomes earned by resource owners (factors of production) for
their contribution to the production of different goods & services in a year”

▪ NI = NNP – Indirect Taxes + Subsidies

▪ This concept throws light on the distribution side of national output

Personal Income (PI)

“PI is the sum of all incomes all received by the individuals and households in a during one
year”

▪ PI = NI – Corporate Income Taxes – Undistributed Profits – Social Security

contributions + Transfer Payments
 ▪ This concept help us to know the potential purchasing power of the people and
households and the welfare of consumers in society

Disposable Personal Income (DPI)

“DPI is that part of personal income which is left after the payment of personal direct taxes”

▪ DPI = PI – Personal Direct Taxes

▪ DPI = Consumption + Saving

▪ This concept indicates the purchasing power in the hands of the people and their actual
living standards

Methods of Measuring National Income

1. Product method
2. Income method
3. Expenditure method

Importance of National Income

▪ Know the Production performance & achievements

▪ Indicates the living standards of the people
▪ Know whether a country is growing, stagnant or declining
▪ Shows the contribution made by various sectors to NI
▪ Know the purchasing power of money

Importance of Measuring National Income

▪ Contains figures of consumption, savings, investments, imports & exports

▪ Know relative roles played by public & private sector
▪ Helps central government to decide amount of grants-in-aids to different state
governments
▪ Valuable guide to formulate economic policies
▪ Reveals cyclic behaviour of an economy and also helps in forecasting

Challenges in Measuring National Income

❖ Theoretical Or Conceptual Difficulties

▪ Definition of the term “nation” in National Income

▪ Choice of method for measuring the National Income
▪ Only goods & services having monetary value included
▪ Stage at which National Income is estimated

❖ Practical Or Statistical Difficulties

▪ Non availability of data

▪ Absence of trained personnel
▪ Absence of proper records
▪ Existence of non-monetized sector
 ▪ Absence of occupational specialization

❖ Practical Or Statistical Difficulties

▪ Problem of double counting

▪ Existence of illegal earnings
▪ Existence of non-market transactions
▪ Coverage of commodities & services

2. MONEY AND BANKING

BARTER SYSTEM
existed in early times when a commodity was exchanged for another. It was
difficult to carry out transactions under this system due to many problems that came
between the people who transacted. One of the major problems was ‘double coincidence
of wants’.
Introduction of money has solved all these problems.
MONEY
Money is a commonly accepted ‘Medium of Exchange’. It is also a ‘Measure of
Value’, a ‘Store of Value’ and a ‘Standard of Deferred Payments’.
MONEY SUPPLY
Money Supply refers to the total quantity of money in circulation in the economy
at a given point of time. It is a stock variable since the total stock of money in circulation
among the public is measured at a particular point of time.

The components of M1 supply of money are:-

M1 = CC + DD + Other deposits with RBI.
1) Currency and coins held by the public.
a) The currency issued by the Central Bank is called ‘High Powered Money’.
b) Currency notes & coins are called ‘Legal Tender.’
c) Currency notes & coins are called ‘Fiat Money’.
2) Net demand deposits held by the commercial banks (only deposits of the public held
by the banks)
a) Demand deposits created by commercial banks are called ’bank money.’
b) Interbank deposits not included.
3) Other deposits with the RBI (demand deposits of foreign Central banks and
international financial institutions.)
[M2 = M1 + Savings deposits with Post office savings bank
M3 = M1 + Net time deposits of commercial banks.
M4 = M1 + Total deposits with post office savings organisations (excluding NSC)]

M1 is the most liquid form of money supply and is referred to as ‘narrow money’.
M2 is also narrow money while M3 and M4 are broad money. The level of liquidity
decreases from M1 to M4.
Money supply is created by a system comprising of two types of institutions – Central
Bank of the economy (RBI) and Commercial Banking System.
Central Bank of India or RBI regulates the supply of money in the economy by issuing
currency notes. It controls money supply in the country through bank rate, open market
operations and variations in reserve ratios.
Commercial Banks are the other type of institutions which are part of the money creating
system in the economy.
COMMERCIAL BANKS
Commercial Banks are financial institutions which accepts deposits from the general
public and extends loans for investment with the aim of earning profit. The interest paid
by the commercial banks to depositors is lower than the rate charged from the borrowers.
The difference between these two interest rates is called the ‘spread’ and is the profit
appropriated by the bank. Two distinctive functions of commercial banks are borrowing
and lending, or in other words accepting deposits and giving loans.

Demand deposits can be withdrawn on demand by depositors by issuing a cheque. They

are also referred to as chequable deposits. Since they are highly liquid they are treated
as part of money supply. Current account deposits and savings account deposits are
demand deposits.

Time deposits also called as fixed or term deposits. They are kept with the bank for a
fixed period and can be withdrawn only after the expiry of the specified period. Interest
on time deposits are higher than those on savings account deposits.
Credit Creation/ Deposit Creation/ Money Creation by Commercial Banks
Commercial banks receive deposits from the public. It cannot use the total
deposits for giving loans. It is legally compulsory for the banks to keep a certain
minimum fraction of net demand and time deposits as legal reserves. This
fraction is called Legal Reserve Ratio ( LRR).
Credit creation is a process by which a commercial bank creates total deposits
which is number of times the initial deposit.

LRR has two components 1) Cash Reserve Ratio

2) Statutory Liquidity Ratio
Credit Multiplier = 1/ Legal Reserve ratio
Total credit creation = Initial deposit x 1/ Legal Reserve Ratio
Credit creation is based on the following assumptions –
1) There is a single banking system in the economy.
2) All transactions are routed through banks.
3) A depositor does not normally withdraw his entire deposit at one time.
Credit Creation by Commercial Banks (Initial deposit = Rs.1000 & LRR = 20%)

Rounds Deposits (Rs.) Loans (Rs.) Reserve (Rs.)

I 1,000 800 200
II 800 640 160
III 640 512 128
“ “ “
“ “ “
TOTAL 5,000 4,000 1,000
Suppose a customer deposits Rs.1,000 in a bank and the legal reserve ratio is 20% as
proposed by RBI. The bank will retain Rs.200 to meet customer obligation and
remaining Rs. 800 is lent to others. Those who borrow, will spend and the amount will
come back to the bank as deposits. Now bank retains 20% of Rs. 800, ie, Rs. 160 and
the remaining Rs. 640 is available for lending. This process continues till there is no

further amount available for lending. Money multiplier is 5 and when the initial deposit
is Rs. 1000, the total deposits in the banking system will be Rs.5,000. This is how
commercial banks are able to create credit multiple times the initial deposit.
 Central Bank of India or The Reserve Bank of India is a very important institution in
modern India. It was instituted on 1st April, 1935.

It is the apex institution of a country’s monetary system. The design and control of the
country’s monetary policy is its main responsibility.
FUNCTIONS OF CENTRAL BANK

1) Authority of Currency Issue / Bank of Issue – The RBI is the sole authority for the issue
of currency in the country. It promotes efficiency in the financial system, leads to
uniformity & monopoly in the issue of currency and has a direct control over money
supply. The currency issued by the Central Bank can be held by the public or the
commercial banks and is called ‘the high- powered money’ or ‘reserve money’.

2) Banker to the Govt./ Govt’s Bank–Banker to both the Central and State Govts.
Maintains balances, arranges and manages funds of the Govt. Accepts receipts and
makes payments for the Govt. Manages public debt and is the financial advisor to the
Govt. etc.

3) Banker’s Bank – Holds surplus cash of commercial banks. Gives loans to them when
they are in need (Lender of the last resort). Cheque clearing and remittance facilities.
(Clearing House) Supervisor and regulator of banking system.

4) Controller of Credit – It is the most crucial function played by the RBI in modern times.
It removes causes for price instability, effectively controls economic activities and
mobilises credit in the desired direction. The RBI controls the supply of money in the
economy through Quantitative and Qualitative tools.

Quantitative Measures – 1) Bank Rate – is the rate of interest at which RBI lends to
commercial banks for long term. During deflation or recession, in order to increase the
supply of money the RBI reduces the bank rate. Commercial banks in turn will reduce
their lending rates which results in mor investments and money supply.

a) Repo rate – is the rate at which RBI lends to commercial banks for short term
requirements. To increase borrowings by the public and increase money supply, RBI
reduces the repo rate.

b) Reverse Repo Rate – When commercial banks have surplus funds, they can deposit the
same with the RBI and earn interest. This interest is the reverse repo rate. When this rate
is decreased it discourages commercial banks to park their funds with RBI. It increases
the lending capacity of banks.

Open Market Operations – refers to buying and selling of Govt. securities from /to the
public by the RBI on behalf of Govt.. During inflation, Govt. securities are sold to the
public and in turn cheques are given to RBI. This reduces the amount of money in
circulation and the capacity of commercial banks to lend.
3) Legal Reserve Ratio – is the minimum reserve that a commercial bank must
maintain as per the instructions of RBI. Its components are cash reserve ratio and
statutory liquidity ratio.
CRR – fraction of net total demand and time deposits that commercial banks must keep
as cash reserves with RBI.
 SLR - fraction of net total demand and time deposits that commercial banks must keep
with themselves in the form of liquid assets.
When CRR or SLR or both are increased, commercial banks will have less money for
lending operations. This reduces money supply.
Qualitative Measures –
1) Margin Requirement – on loan refers to the difference between current market value
of the security offered and amount of loan granted by the banks. If margin imposed is
40% then only 60% of the value of the security will begiven as loan. Margin
requirements are lowered to allow borrowers to borrow more and increase supply of
money in the economy.
2) Moral Suasion – The RBI cautions the commercial banks to persuade its customers
to either invest more during deflation or invest less during inflation.
3) Selective Credit Control – The commercial banks scrutinise extensively and sanction
loans only for a few projects which are absolutely necessary for the economy. This
happens during times of inflation

Difference between RBI and Commercial Banks

Central Bank of India or RBI Commercial Banks
1) It is the apex bank in the money market It is one of the units in the banking
of a country. structure.
2) Its primary aim is general public welfare. Its primary aim is profit.
3) It has monopoly right to issue currency. It is denied this function.
4) It cannot deal with the public. It deals with the public and business
firms.
Clearing House – Banks receive cheques drawn on the other banks from their customers
which they have to realise from their drawee banks. Similarly, cheques on a particular
bank are drawn and passed into the hands of other banks which have to realise them
from the drawee banks.

1) If the initial deposit is Rs. 5,000 and the LRR is 25%, frame a schedule to show how
credit is created by the commercial banks.

2) Total deposits created by commercial banks is Rs. 12,000 crore and LRR is 20%,
calculate the amount of initial deposit.

3) Calculate LRR if the initial deposit of Rs. 10,000 crore leads to a creation of total
deposits of Rs. 1,00,000 crore.

3. INFLATION

What is Inflation?

Inflation
➢ Inflation is defined as a rise in the general price level over a period of time.
➢ In other words, prices of many goods and services such as housing apparel, food,
transportation, and fuel become dearer during inflation.
Deflation
➢ Deflation is defined as fall in the general price level over a period of time.
Both Inflation and Deflation create Problems…
What happens during Inflation : Value of Money goes down↓↓ and Prices rise High↑↑
Types of Inflation
 ➢ Creeping Inflation
➢ Walking or trotting Inflation
➢ Running Inflation
➢ Galloping Inflation
➢ Hyper Inflation
Theories and Causes of Inflation
• The main cause of inflation is the increase in the demand of goods and services and at
the same time decrease in the supply of goods and services.
• There are two theories related to the causes of inflation:
✓ Demand-pull (when there is excess demand), and
✓ Cost-push (when costs rise)
Theories and Causes of Inflation
Demand Pull Inflation –
This occurs when there is excess aggregate demand in the economy (overall) or in a specific
market or industry. Businesses respond to high demand by raising prices to increase their profit
margin

Cost – push Inflation :

This occurs when costs of production or operation are increasing.

• Cost Push inflation is mainly caused due to the following factors:

· increase in wages.
· increase in cost of
raw materials
· increased cost of
imported components
(import-push inflation)
 Growth vs. Inflation: India, 1951-2011

Average annual growth Average annual

Period rate of GDP at constant rate of
prices (%) WPI inflation (%)

2005-06 to 2010-11 8.47 6.55

2000-01 to 2005-06 6.93 4.68

1995-96 to 2000-01 5.92 5.07

1990-95 to 1995-96 5.38 10.18

1980-81 to 1990-91 5.64 8.51

1970-71 to 1980-81 3.16 10.28

1960-61 to 1970-71 3.75 6.24

1950-51 to 1960-61 3.94 1.75

WPI - Wholesale Price Index
- measured weekly in India

The Indian evidence above shows the lack of any simple unidirectional relationship between
inflation and growth.
Rate of Inflation
The relative price of food is computed as the ratio of the WPI component for primary food
commodities to an index of non-food manufacturing prices computed from WPI data.
Why is Inflation a Problem in India?

Price Effects :

Inflation makes some people worse off, but it makes others better off
Example:

1. Increase in Gasoline prices affect the Truck drivers more but barely affects people who
go to there work by walk and economy vehicles
2. College tuition fees has risen almost twice as fast as average prices over the past 10
years, which hurts you a lot, but may have little impact on a married couple with no
children.
3. Poultry diseases causes a rise in the prices of Non-veg food items and affect people who
eats more of Non-veg food items but it barely affects people eating Veg food.
4. People in Cities get affected more than people in small towns and villages

Income Effects :

Prices for goods and services mean income for some people. So, as some prices increase faster
than other, some people’s income increase faster than others.

Example:

1. Due to increase in number of automobiles working on Gasoline increased, due to this most
of the Oil companies record very high amounts of improvements in profits every year
2. Due to ever increasing in pollution, the number of people suffering from different diseases
also increased which gave chance to many pharmaceutical companies to improve profits
every year
 3. All the retail stores working on % profit’s increase there income when ever there is
increase in prices of goods.

Wealth Effects :

1. Inflation redistributes income between Borrowers and Lenders

2. Inflation benefits the borrowers and hurts the lenders
Reason: As the value of money decreases at higher rate

Inflation redistributes the social conditions of people

Causes of Inflation
Factors on Demand side :
1. Increase in Money Supply
If the currency in circulation increased, there would be a proportional increase in the price
of goods
2. Increase in Disposable Income
Disposable income is total personal income minus personal current taxes. disposable
income is the amount of "play money” left to spend or save. If this is increased people
spend money on unnecessary things and there demand increases and thus inflation
3. Deficit Financing
Government spends more money than it receives as revenue, the difference being made
up by borrowing or minting new funds, minting new funds decrease the value of money
and thus inflation
4. Foreign exchange reserves
Foreign exchange reserves include foreign currency deposits and bonds and also adds
gold reserves, which increase the circulation of money and thus inflation

Factors on Supply Side :

1. Rise in administered prices
Prices decided by an individual producer or seller not purely by market forces, this is
common when there is only one supplier and he has chance to increase the cost without
any conditions
2. Erratic agricultural growth
India is country where in 60% of people still relay on farming and the weather is so uneven
and prices depend on the agricultural productivity
3. Agricultural price policy
Due to fluctuating prices during mid 60’s during the Pakistan war APP was introduced to
ensure stability in prices, so when the supply decreases, they have to manage the prices in
order to stabilize the cost and inflation occurs
4. Inadequate industrial growth
Most of the markets in India run foreign imported products due to lack of technology and
other issues, so the pieces also keep fluctuating on the other countries markets and market
value and too much imports can lead to fall of value of money

Printing of Money is Never a Solution for Inflation

Factors on Demand side

Increase in Printed Money

 Increase in Disposable Income
Due to Increase in disposable money people spend money lavishly independent of there
necessity and thus there is increase in Inflation
Mainly seen in IT Sector in India due to its speedy growth
Deficit Financing
This happens every year in India and India has a debt of 172 Billion Dollar up-to now and
still unable to repay it to World bank
Foreign Exchange Reserves
Forex reserves increase every week due to good participation of foreign companies and latest
reports from RBI says 293 Billion Dollar investment from Foreign companies
Factors on Supply Side
Rise in administered prices
In case of India the administer can be government or individual if it is government then it is
a fixed price if it is on the individual then there is lot more variations based on ones decision
costs are decided
Erratic agricultural growth
Vegetable Max Cost/kg Min Cost/kg
Tomato 60 5
Potato 30 14
Onion 70 20
Cauliflower 45 20
Brinjal 45 20
Factors on Supply Side
Agricultural price policy
Though APP was successful for in some regions but due to poor Infrastructure the food grains
and vegetables stored always get spoiled and due this the demand supply would decrease
Inadequate industrial growth
GDP growth which clearly depicts Industrial Growth
Effect of Inflation
• They add inefficiencies in the market and make it difficult for companies to budget or
plan for long term
• Uncertainty about the future purchasing power of money discourages investments and
savings
• There can be negative impacts to trade from an increased instability in currency
exchange prices caused by unpredictable inflation
• If the inflation rate in the economy of a country is higher than rates in other economy’s
there will be huge increase in imports and decrease in exports (in terms of vaule) and
hence huge fall in GDP
• Higher income tax rate
• Value of money decreases
Measures to control Inflation
1. Effective policies to control inflation need to focus on the underlying causes of
inflation in the economy
Example:
1. If the main cause is excess demand for goods and services, then government
policy should look to reduce the level of aggregate demand
2. If cost-push inflation is the root cause, production costs need to be
controlled for the problem to be reduced
Step to be taken
Investment in infrastructure and human capital to ensure that desired growth does not
exceed the productive capacity of the economy.
If Inflation is for short period of time and If not Food Inflation
Step to be taken
2. In the short-run the RBI should raise interest rates sharply to protect its anti-inflationary
credibility.
3. To eradicate Erratic agricultural growth problem
Step to be taken
 Investment and promotion of organizational innovations in agriculture to ensure that
food supply does not become a bottleneck to growth and price to price (cost effectively)
4. Demonetization of Currency.
Step to be taken
Primarily to curb unaccounted money. The higher denomination banknotes in Rs.5000
and Rs.10000 were to reintroduced and these banknotes (Rs.5000 and Rs.10000) were
to be demonetized.
5. A strong Fiscal Policy Reduction in unnecessary expenditure by the government
Step to be taken
Expenditures on public functions and rally's and public meeting, usage high standards
Infrastructure by public officials need to be decreased to certain fixed level
6. Check on the amount the government sector borrows each year
7. Moving towards greater independence for the central bank and transparency in
monetary policy to stabilise inflationary expectations.
8. Increase in Savings
Policy recommended for short-run
Fiscal consolidation to ensure that fiscal policy does not work at cross-purposes with
monetary policy.
• A loose fiscal policy, by increasing the debt burden both directly and through its effect
on interest rates, would prove to be unsustainable in the long run
• As the debt burden rises, the pressure to print money to finance the fiscal deficit would
rise, thereby making it impossible to pursue an anti-inflationary monetary policy.
What happens with fiscal Policy
• These fiscal policies increase the rate of leakages from the circular flow and reduce
injections into the circular flow of income and will reduce demand pull inflation at the
cost of slower growth of economy
4. UNEMPLOYMENT
Unemployment refers to a situation in which the workers who are capable of working and
willing to work do not get employment.
Types of unemployment
 Frictional unemployment
 Structural unemployment
 Cyclical or Keynesian unemployment
 Seasonal unemployment
Frictional unemployment
Frictional unemployment occurs when a worker moves from one job to another. It is a
result of imperfect information in the labor market, because if job seekers knew that
they would be employed for a particular job vacancy, almost no time would be lost in
getting a new job, eliminating this form of unemployment.
Structural unemployment
Structural unemployment arises when the qualification of a person is not enough to meet
his job responsibilities. Conversely, structural unemployment arises when the salary
offered to a person falls short of the minimum wage that can be paid for the concerned
job.
Cyclical unemployment
Cyclical or demand deficient unemployment occurs when the economy is in need of low
workforce. The demand for labor increases with the economy in the growth phase.
Again, when the economy passes through depression, demand for labor decreases and
the extra workers are released as the unemployed labor force.
 Seasonal unemployment
• Seasonal unemployment occurs when an occupation is not in demand at certain
seasons.
Causes of unemployment
 High Population growth.
 Absence of employment opportunities.
 Seasonal Employment.
 Joint Family System.
 Increasing turnout of students from Indian Universities.
 Slow Developing of Industries.
 Insufficient Rate of Economic Progress.
Costs of unemployment

 Individual : Unemployed individuals are unable to earn money to meet financial needs.
Failure to pay installments or to pay rent may lead to homelessness through eviction.
Unemployment increases chances of malnutrition, illness, mental stress, and loss of self-
esteem, leading to depression.

 Society: An economy with high unemployment is not using all of the resources, i.e.
labor, available to it. Since it is operating below its production capability, it could have
higher output if more people are usefully employed.

 However, there is a difference between economic efficiency and unemployment: if the

frictionally unemployed accepted the first job they were offered, they would be likely
to be operating at below their skill level, reducing the economy's efficiency.
Measurement

 Economists typically focus on the unemployment rate. The unemployment rate is

expressed as a percentage, and is calculated as follows:

 Unemployment rate=unemployed worker/total labor force *1oo

As defined by the International labor organization, "unemployed workers" are those
who are currently not working but are willing and are able to work for pay, currently
available to work, and actively searching for work

Solutions

 A Change in the pattern of investment

 Encouragement to small enterprises as against big enterprises
 Problem of Choice of technique
 Encouragement of New Growth Centers in Small Towns and Rural Areas
 Subsidies on the Basis of Employment
 Reorientation of Educational Policy
Unemployment Rate Since 1960
5. MONETARY AND FISCAL POLICY
MONETARY POLICY
Monetary policy refers to the use of instruments under the control of the central bank (RBI)
to regulate the availability, cost and use of money and credit.
According to Johnson, “Monetary policy is defined as policy employing central bank’s
control of the supply of money as an instrument for achieving the objectives of general
economic policy.”

OBJECTIVES OF MONETARY POLICY

✓ Full Employment
✓ Price Stability
✓ Economic Growth
✓ Balance of Payments
INSTRUMENTS OF MONETARY POLICY
• BANK RATE
• CASH RESERVE RATIO (CRR)
• STATUTORY LIQUIDITY RATIO (SLR)
• REPO RATE & RESERVE REPO RATE
• OPEN MARKET OPERATIONS
BANK RATE
• Bank Rate is also known as discount rate.
• It is the rate at which RBI lends to the commercial banks or rediscounts their bills.
• If bank rate is increased, then commercial banks also charge higher rate of interest on
loans given by banks to public because now commercial banks get funds from RBI at
higher rate of interest.
• Higher rate of interest will contract credit in the economy i.e. public will take lesser
loans because of higher rate of interest.
• The current bank rate is 6.75%
CASH RESERVE RATIO (CRR)
 • Cash Reserve Ratio is a certain percentage of bank deposits which banks are required
to keep with RBI in the form of reserves or balances.
• Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.
• RBI is empowered to vary CRR between 15 percent and 3 percent.
• But as per the suggestion by the Narshimam committee Report the CRR was reduced
from 15% in the 1990 to 5 percent in 2002.
• The current CRR is 4.00 %.
Statutory Liquidity Ratio (SLR)
• It means a certain percentage of deposits is to be kept by banks in form of liquid
assets.
• This is kept by bank itself the liquid assets here include government securities,
treasury bills and other securities notified by RBI.
• If SLR is more then banks have to keep more part of deposits in specified securities
and banks will have less surplus funds for granting loans. It will contract credit.
• SLR is fixed by RBI and usually it has been ranging between 25% to 40%. By an
amendment of the Banking regulation Act(1949) in January 2007, the floor rate of
25% for SLR was removed.
• The current SLR is 20.75 %.
REPO RATE & RESERVE REPO RATE
• Repo rate is the rate at which RBI lends to commercial banks generally against
government securities. Reverse Repo rate is the rate at which RBI borrows money
from the commercial banks.
• Reduction in Repo rate helps the commercial banks to get money at a cheaper rate and
increase in Repo rate discourages the commercial banks to get money as the rate
increases and becomes expensive.
• As the rates are high the availability of credit and demand decreases resulting to
decrease in inflation.
• This increase in Repo Rate and Reverse Repo Rate is a symbol of tightening of the
policy.
• The current repo rate is 6.25 % and reserve repo rate is 5.75 %.
OPEN MARKET OPERATIONS
• It means that the bank controls the flow of credit through the sale and purchase of
securities in the open market.
• When securities are purchased by central bank, then RBI makes payment to
commercial banks and public. So, the public and commercial banks now have more
money with them.
• It increases money supply with commercial banks and public. This will expand credit
in the economy.
• In year 2012-13 RBI Purchases securities 8,000 crore

FISCAL POLICY
• “It refers to a policy concerning the use of state treasury or the government finances to
achieve the macro-economic goals”
OR
• “Government policy of changing its taxation and public expenditure programs
intended to achieve its objective”.
OR
• “Government uses its expenditure and revenue program to produce desirable effects
on National Income , production and employment”.
OBJECTIVES OF FISCAL POLICY
✓ To Achieve Equal Distribution of Wealth
✓ Increase in Savings
✓ Degree of inflation
✓ To Achieve Economic Stability
✓ Price stability
INSTRUMENTS OF FISCAL POLICY
• DEFICIT POLICY
• PUBLIC EXPENDITURE
• TAXATION POLICY
• PUBLIC DEBT
DEFICIT POLICY

• Deficit Financing refers to financing the budgetary deficit.

• Budgetary deficit here means excess of government expenditure over government
income. It means “Taking loans from reserve bank of India by the government to meet
the budgetary deficit” .
• Reserve bank gives loans buy issuing new currency notes. Increase in money supply
leads to fall in value of money. Fall in value of money in turn leads to increase in price
level. So deficit financing should be kept low as it leads to price rise in economy.
• Thus due to deficit financing necessary funds are made available for economic Growth
and on the other inflation of country increases
PUBLIC EXPENDITUTRE

• Public expenditure influences the economic activities of country very much.

• Public expenditure may be of two kinds i.e. developmental and non developmental.
• Expenditure on developmental activities requires huge amount of capital. So much
capital cannot be made available by private sector alone. It requires substantial increase
in public expenditure.
• Public expenditure may be made in many ways:- (1) Development of state enterprises,
(2) Support to private sector, (3) Development of infrastructure & (4) Social Welfare.
TAXATION POLICY

• Taxes are the main source of revenue of government.

• Government levies both direct and indirect taxes in India.
• Direct taxes are those which are directly paid by the assesses to the government i.e.
income tax, wealth tax etc. Indirect tax are paid indirectly by the public to the
government i.e. excise duty, custom duty, VAT etc.
• Direct tax are progressive in nature. Indirect tax are not progressive.
• These change from all the segments of society at same rate.
• The main objectives of taxation policy are: (1) Mobilization of resources, (2) To
promote saving, (3) To promote saving & (4) To bring Equality of income and wealth
PUBLIC DEBT

• Government needs lot of funds for economic development of the country. No

government can mobilize so much funds by way of tax alone.
• It is therefore , becomes inevitable for the government to mobilize resources for
economic development by resorting the public debt.
• Public debt is obtained from two kinds:- (1) Internal Debt (2) External Debt
• Public Debt of Year (In crores of Rupees)
 31st March 2013 31st March 2014
Internal debt 48,66,829.00 54,68,622.11
External debt 1,72,302.01 1,82,862.11
Total 50,39,131.01 56,51,484.22