CU-BBA-SEM-V-Business environment-Second Draft

Fig 3.5: Steps in Environmental Forecasting Identification of Relevant Variables: There are so many different variables are present in the environment which has different relevance for different business. For instance, skilled labour is important for IT industries but unskilled labour is in high demand in construction business. So, one variable is relevant for one industry and it might be not relevant for other industry. It is very important to identify the critical environmental variables and also understand their respective trend and anticipate their future trends to avoid misleading effects. Pearce and Robinson has highlighted the basis of selecting the relevant variables in following ways i. Include the variables with significant effect even though there are less chances of their occurrence. ii. Skip major disasters like Nuclear War. iii. Aggregate relevant variables into gross. iv. Consider all dependent variables separately Collection of Information: It involves identification of the type of information and its relevant source, and selection of methods of data collection. Selection of Forecasting Techniques: The selection depends on the availability of information, amount and accuracy of information, the cost, time-frame, the competence of manager and experts working on it, importance of forecasts and nature of forecast decision. These techniques are further classified into Quantitative and Qualitative. Qualitative Forecasting techniques are very significant when business needs to consider political, legal, social and technological factors. While for Quantitative method validity and accuracy of data is must. 51 CU IDOL SELF LEARNING MATERIAL (SLM)

Monitoring: It is vital aspect of Forecasting as relevant factors may get change with time or period. Also, the trends of variables keep on changing from time to time abruptly, so strong monitoring methods ensures the proper efficiency of forecasting method 3.5 SUMMARY  It is a continuous process wherein the role of manager is to examine the factors of external environment for achieving optimum performance of business.  Environmental Scanning/Analysis has two approaches:  Outside -in (Macro approach): Develops alternative scenarios  Inside – out (Micro approach): Forecasts immediate future environment  The process of environmental scanning / analysis is split into four stages- Scanning, Monitoring, Forecasting and Assessment  Environmental scanning is extensively a process or method of information- collecting, searching, organizing and understanding.  Types of Environmental Scanning-  Ad-Hoc - It is conducted to handle specific problem  Continuous - scanning is conducted at regular intervals  Periodic- where a specialized team is allocated the function of scanning  Techniques of Environmental Scanning:  SWOT- explore all elements of business strengths, weaknesses, opportunities and threats  ETOP - It is the method in which external environment of business is structured by considering its factors.  Verbal and written information for analyzing the trends  Environmental Forecasting - anticipating the future performance of an organization 3.6 KEYWORDS  Environmental scanning is extensively a process or method of information- collecting, searching, organizing and understanding  Assessment: the action of assessing someone or something.  Forecasting -predict or estimate (a future event or trend).  Monitoring - observe and check the progress or quality of (something) over a period 52 CU IDOL SELF LEARNING MATERIAL (SLM)

of time; keep under systematic review  Environmental Forecasting - anticipating the future performance of an organization, 3.7 LEARNING ACTIVITY 1. What is the role of Monitoring step in Environmental Scanning Process. ___________________________________________________________________________ ___________________________________________________________________________ 2. Explain the strategies that can be incorporated with SWOT analysis ___________________________________________________________________________ ___________________________________________________________________________ 3.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Discuss the approaches of Environmental Scanning. 2. Write a note on Verbal and Written information Technique of Environmental Scanning. 3. Explain the concept of Environmental Scanning 4. Elaborate the process of Environmental Scanning 5. Why forecasting the future trend is an important aspect of Scanning Process. Long Questions 1. Why ETOP Analysis is considered to structure the Business Environment factors? 2. SWOT analysis provides fair understanding of core competency of an organization. Explain the significance of SWOT in dealing with external environment factors. 3. Why Environmental Forecasting is assumed to help the organization to meet the expected performance standards? 4. How Environmental Analysis allows organization to take proper strategic action? 5. Compare the Merits and Demerits of SWOT and ETOP analysis. How the preference of the method is decided by the Organization? B. Multiple Choice Questions: 1. The method to analyze the environment and recognize the impact of direct or indirect elements of environment on the business. 53 CU IDOL SELF LEARNING MATERIAL (SLM)

a. Monitoring b. Scanning c. Evaluating d. Assessing 2. In which method, Survey is conducted to co-relate the implications of different environmental factors for short – run. a. Ad-Hoc b. Periodic c. Random d. Continuous 3. It highlights such factors that can be harmful if used against the company by its competitors or the company lags behind in it represents______________ of an organization. a. Threats b. Strengths c. Opportunities d. Weakness 4. When organization can ____________ its strength to the market forces then opportunities are used for gaining advantages by the organization a. Co-relate b. Identify c. Ignore d. Be flexible 5._______________ depends on the availability of information, amount and accuracy of information, the cost, time-frame, the competence of manager and experts working on it, importance of forecasts and nature of forecast decision a. Analysis b. Feedback 54 CU IDOL SELF LEARNING MATERIAL (SLM)

c. Environmental Forecasting d. Improvement in the process. Answers 1-b, 2-a, 3-d, 4-a, 5-c 3.9REFERENCES Text Books:  Francis Cherunilam , Business and Environment, Text and Cases, [Himalaya Publishing House],  C. Fernando, Business Environment Kindle Edition, Pearson  K.Aswathappa, Essentials Of Business Environment, Himalaya Publishing House  SHAIKH SALEEM, BUSINESS ENVIRONMENT, Pearson  Ian Worthington, Chris Britton, The Business Environment, Financial Times/ Prentice Hall.  Justin Paul, “Business Environment”, Tata McGraw Hill Publications  P.K.Ghosh : “Business Environment”, Sultan Chand Publishers, New Delhi Reference Books:  Engineering Economic-Dr. Rajan Mishra by University Science Press  The Gazette of India, Ministry of Law and Justice, New Delhi. No.311, June’16, 2006.  Morrison J, The International Business Environment, Palgrave  MISHRA AND PURI, Indian Economy, Himalaya Publishing House, New Delhi  Business Environment Raj Aggarwal Excel Books, Delhi  Strategic Planning for Corporate Ramaswamy V McMillan, New Delhi  Dahl Modern political analysis. Englewood Cliffs, N.J: Prentice-Hall. Open Text Source:  Dhamija, Dr. Ashok (2009). Prevention of Corruption Act. LexisNexis India. p. 2049. ISBN 9788180385926.  Subrata K. Mitra and V.B. Singh. 1999. Democracy and Social Change in India: A Cross-Sectional Analysis of the National Electorate. New Delhi: Sage 55 CU IDOL SELF LEARNING MATERIAL (SLM)

Publications. ISBN 81-7036-809-X (India HB) ISBN 0-7619-9344-4 (U.S. HB).  Bakshi; P M (2010). Constitution Of India, 10/e. Universal Law Publishing Company Limited. pp. 48–.ISBN 978-81-7534-840-0.  International Journal of Scientific and Research Publications, Volume 2, Issue 12, December 2012  www.yourarticlelibrary.com  https://courses.lumenlearning.com/ 56 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 4: DIFFERENT ECONOMIC SYSTEMS AND ECONOMIC POLICIES STRUCTURE 4.0 Learning Objective 4.1 Introduction 4.2 Economic System 4.3 Types of Economic System 4.3.1 Capitalist Economy 4.3.2 Socialist Economy 4.3.3 Mixed Economy 4.4 Types of Economics on the Basis of Level of Development. 4.5 Summary 4.6 Keywords 4.7 Learning Activity 4.8 Unit End Questions 4.9 References 4.0 LEARNING OBJECTIVES After studying this Unit, you will be able to  Explain the significance of Economy and Economic System  Highlight the features of Capitalist, Socialist and Mixed Economy  Analyze the basis of classification of economic system  Co-relate the economic development with the type of economic system adopted by different countries 4.1 INTRODUCTION The function of economy is dependent on the correlation and existence of socio-cultural and political factors. All business activities are conducted according to the prevailing economic system of the country. Economic activity is part of our daily life like a simple activity of buying food pack from the grocery shop that involves transaction of money to exporting a big consignment of medicines to foreign land that involves lots of formalities and procedure. 57 CU IDOL SELF LEARNING MATERIAL (SLM)

Economic activities differ from region to region within the country and from country to country. Presence of natural resources, skilled and unskilled labour and government policy all are the deciding factor for different types of business undertakings. India is an agricultural land, because since long time Indian were primarily engaged in agricultural activities for their livelihood and then slowly different allied industries came into existence like poultry, pesticide and fertilizers, etc. The development and growth of different industries is possible when economic system is inclined for the same. Economic system organizes all essential economic institutions, economic resources and economic initiatives together for production of goods and services that will satisfy the needs and wants of the people of country and sets interchange of money for availing different form of utility. 4.2 ECONOMIC SYSTEM Economic system is the way to collect the resources and allocate the resources across the different region of the country. It monitors the inputs of production, administer different level of institution and agencies and built economic structure of the country. Economic system sustains livelihood. It provides employment and to develop the means necessary for meeting the needs of human beings. The structure of earning livelihood has got changed and now more complexities are involved in sustaining such opportunity. The changing elements of environmental factors and norms related to the economic activity has completely changed the characteristics of economic activities. Economy has inter-linked aspects that involves production, consumption and money supply and it should follow ethical norms and stick to legal structure of the region and country. Important features of Economy are as follows: Economy is man-made. Economic institutions are designed, terminated, modified and restructured. After Independence, Zamindari system got eliminated from our land and now we have more comprehensive laws and acts related to land matters. USSR has adopted communism in 1917 over capitalism and then finally adopted mixed structure in 1989. The structure and pattern of economic activities keeps on changing. Manufacturing and utilization are the main activities of an economy and money acts as channel for interchange. Manufacturer and customer adopt dual role i.e., they are same individual. As manufacturer they manufacture goods and services and consumes the same as well. Privatization is gaining more popularity now-a -days as an intervention of government is not much required. 58 CU IDOL SELF LEARNING MATERIAL (SLM)

4.3 TYPES OF ECONOMIES There are different types of Economic System which are adopted across the World. This classification is based on inclination of power and authority, administration of an economic activity, emphasis placed on different objectives and means to achieve all. The dominance on the means of production or resources or ownership either to Government or to private business owners or joint form between Government and Private Player forms the basis of classification of the economic system. Economies are described on the basis of autonomy, profit motives and social welfare. Economic system is classified as follows: Capitalist Economic Mixed System Economy Socialist Fig 4.1: Types of Economic System 4.3.1 Capitalist Economy: Adam Smith, the father of modern economy has given the supporting theory and framework for Capitalist Economic System. The main feature of this system are principle of laissez faire is followed, autonomy is in the hands of private entrepreneurs or business owners, market forces are the deciding factor justifies the uncontrollable nature of the economic system will help the economy to utilize its full capacity for growth and there will be sky high development. So, as per this system, government has no role or no involvement in economic activities. Highlights of Capitalist Economy are as follows: (i) Privately owned property: Right to own, buy, sell, transfer any property which an individual has earn or inherited. The property can be used for production of goods and services and thus profit earned will be enjoyed by the person and his family. There are no legal bindings involved in it. It also has been proved that when Individual has complete charge of its property then they put more hard work and dedication to make it fruitful and gain good returns for the same. Alternatively, if property is owned by the state then the efficiency of individual contribution gets reduced and benefits are not completely enjoyed. 59 CU IDOL SELF LEARNING MATERIAL (SLM)

The popularity of capitalism is because of this important feature where individual enjoys the property and after death that is passed to legal heirs. (ii) Liberty of enterprise: A very important aspect of Capitalist is Liberty. Entrepreneurs, group of owners are free to choose any business or industry and decide upon various factors of production. They can select any market for selling their goods and services. Owner and group of investors bear all the risk of uncertainty, liability for profit and loss. Employees and workers are free to select any industry or occupation for their livelihood. There are no formalities involved for business and employees for entry and exit from specific industry. Liberty is allowed till no harm is made to any society, group or state. Such economic system has very distinct industries from consumer and capital goods, services of different types, untapped and unfamiliar sectors, Technology oriented business, etc. Such factors are responsible for accelerated economic development and wide variety of industries. (iii) Consumer’s Predominance: Consumer wish is the command for business. Consumer dominates the quality and quantity of goods produced. Consumer enjoys freedom of choice, saving or spending money. Even the prices of goods and services are dependent on the interactivity of consumer. Market system also influence the choice and selection of consumer, but consumer is the decision maker. Consumer predominance is based on following factors like level of earning, availability of choices for goods and services, limits placed on consumption but still consumer enjoys his dominance. (iv) Profit Motive: Profit is the driving force in any economic system. The emergence of the economic activity is concentrated on earning profits. That will validate the interest and risk taken up by the entrepreneurs or investors. The profit motive enhances the passion of business, efforts are more dedicated and production system is more efficient and technology is incorporated at various stages to ensure competitiveness in the market. Hunger and ambition to grow provides great platform for wide variety of product lines and spur in quality. To gain and enjoy more profit drives the economic development of the country. (v) Competition: Malpractices, unfair trade norms, unethical procedure can easily get submerged in Capitalist Industry structure. There is no government interference, no guideline to follow, no restriction to adhere to, no accountability for the society as it is opposite of what Capitalist structure is all about. It can also lead to emergence of monopoly and consolidation of power in hands of few. Still competition exist between large organizations. Competition is an important characteristic of the Capitalist, so government impose certain restriction to protect market from monopolies. For example, in US- The well-known capitalist economy of the World has file case against Microsoft to prevent market from its monopoly in software industry. (vi) Price Mechanism: The demand and supply in the market determines the price of goods and services. If demand is more than supply, then price will increase and vice a versa. Enterprises that adapt to this system of market they make up normal profit while who do not 60 CU IDOL SELF LEARNING MATERIAL (SLM)

adjust are wiped off the market. Market forces also decides the specific industry to develop more as compare to others, as small players will enter in sector that gives more profit. (vii) Limited government interference: Government is assumed to collect taxes and not to interfere in the working of industries and markets. The Government should extend support to the enterprises. But now this view point is getting faded as there is increase in awareness that industrial growth should aid in society welfare. Now-a-days Government plays a role of savior that helps economic system in times of Depression, Recession, wars, etc. Countries like USA, UK, France, Netherland, Spain, Portugal, Australia etc. are known as capitalistic countries where government plays important contribution in economic development. Advantages of a capitalist economic system  More efficient  Less bureaucratic  More innovation Discourages discrimination and forces people to trade with each other – breaking down barriers. Problems of a capitalist economic system Inequality. Capitalist economic systems invariably lead to inequalities of wealth and income. However, it is argued that this inequality provides an incentive for wealth generation and economic growth. Monopoly. In a capitalist society, firms could gain monopoly power over consumers and workers. Environmental problems. A capitalist society driven by the profit motive may take decisions to maximize economic income in the short term but at a cost of environmental problems in the long-term. Types of Capitalism 61 CU IDOL SELF LEARNING MATERIAL (SLM)

Fig 4.2: Types of Capitalism 1. Turbo Capitalism This is a style of capitalism that is unregulated, with financial deregulation, privatisation, and reduced tax rates for the wealthy. • There is no regulation for the banking/finance system in turbo-capitalism. This encourages banks to take risks and profit through sophisticated financial derivatives rather than simple deposit and lending standards. • Less regulation of monopoly power misuse. • Lower income tax and capital gains tax, which rewards high-income earners more. • An uncontrolled labour market with easy hiring and firing of employees and little regulation of working conditions. • Unrestrained capitalism or free market capitalism are other terms for turbo capitalism. 2. Responsible Capitalism Responsible capitalism is a free market economy with some government control to prevent capitalism's excesses and injustices. • An extensive welfare state to safeguard those who are unemployed or have low wages, as part of responsible capitalism. • The majority of industries would be in the private sector, but the government might take responsibility for areas with significant positive externalities and social benefits, such as health care, education, and public transportation. • A readiness to control monopolies and safeguard workers' rights. Responsible capitalism is similar to concepts of a social market economy 62 CU IDOL SELF LEARNING MATERIAL (SLM)

3. Crony Capitalism A word that refers to a situation in which a company's performance is linked to strategic relationships with civil servants, politicians, and people in positions of power. It could allude to instances in the early twentieth century in the United States where business titans were forced to buy off politicians in exchange for favours (e.g., in popular media: Citizen Kane). Arguably a degree of ‘crony capitalism occurs in countries like China, South Korea and Latin America. The power of the Mafia in Italy is also an example of ‘crony capitalism’ 4. Advanced Capitalism A word that refers to societies that have fully established capitalism. There is general acceptance of the status quo, and there is minimal political activism on major problems. Consumption is vital in mature capitalism. To overcome capitalism's worst excesses, there is likely to be an established welfare state. 5. State Capitalism When state-owned industries play a significant part in the market economy, it is referred to as state capitalism. The government also plays a crucial role in planning under state capitalism, such as selecting whether or not to invest in transportation and communication. China has become a model of state capitalism to some extent. Private companies play an important role, but the government also has a say in energy and transportation development, and the Chinese government has a say in monetary and exchange rate policies. The distinction between state capitalism and state socialism is that there is no room for private enterprise or rivalry under state socialism. 6. Vulture capitalism When hedge funds and private equity investors buy companies, they are more concerned with making a personal profit than with the company's long-term success. They could, for example, use a leveraged buyout to acquire the company, then saddle it with debt before selling off assets. The buyers earn from debt service and asset sales even if the firm fails. Popular Capitalism David Cameron, the Conservative Party's leader, expressed his desire for \"popular capitalism.\" This is most likely to reap the benefits of capitalism while also ensuring that everyone benefits from economic progress. This would entail some redistribution and the establishment of a social welfare safety net. To prevent this, it is likely that popular capitalism would be ready to put more restrictions on the financial industry. 63 CU IDOL SELF LEARNING MATERIAL (SLM)

4.3.2 Socialist Economy: In the socialist or centrally planned economies all the productive resources are owned and controlled by the government in the overall interest of the society. A central planning authority takes the decisions. The socialist economy has the following main features. (i) Collective Ownership of means of Production: In a Socialist economy means of production are owned by the government on behalf of the people. The institution of private property is abolished and no individual is allowed to own any production unit and accumulate wealth and transfer it to their heirs. However, people may own some durable consumer goods for their personal use. (ii) Social Welfare Objective: The decisions are taken by the government at macro level with the objective of maximization of social welfare in mind rather than maximization of individual profit. The forces of demand and supply do not play any important role. Careful decisions are taken with the welfare objectives in mind. (iii) Central Planning: Economic planning is an essential feature of a socialist economy. The Central Planning Authority keeping the national priorities and availability of resources in mind allocates resources. Government takes all economic decisions regarding production, consumption and investment keeping in mind the present and future needs. The planning authorities fix targets for various sectors and ensure efficient utilization of resources. (iv) Reduction in Inequalities: The institutions of private property and inheritance are at the root of inequalities of income and wealth in a capitalist economy. By abolishing these twin institutions a socialist economic system is able to reduce the inequalities of incomes. It is important to note that perfect equality in income and wealth is neither desirable nor practicable. (v) No class conflict: In capitalist economy the interests of the workers and management are different. Both of them want to maximize their own individual profit or earnings. This results in class conflict in capitalist economy. In socialism there is no competition among classes. Every person is a worker so there is no class conflict. All are co-workers. Socialism in today’s world Countries such as Russia, China and many eastern European countries are said to be socialist countries. But they are changing now and encouraging liberalization in their countries for their economic development. Different types of socialism Socialism is a political and economic ideology focused with achieving greater distributional equity and providing solutions that entail more cooperation and social solutions. In Socialism, means of production are often under the control of the concept of state ownership. The goal is to govern industry in the best interests of society, not a few property owners. 64 CU IDOL SELF LEARNING MATERIAL (SLM)

However, there are many different types of socialism, ranging from the command economy of State-Communism (e.g., the Soviet Union) to libertarian socialism, which calls for voluntary councils of workers to run their own businesses. Traditional economic theory is built on the notions of individual property ownership and a free market, in which people and businesses are free to act in ways that maximise their utility. From an economic standpoint, this is regarded as an approach that results in the most effective allocation of resources.Various forms of socialism all criticise the free market economy, claiming that it leads to inequality and monopoly power abuse. This market economy faces an assault from socialism. Fig 4.3: Types of Socialism 1. Anarcho-socialism This is a type of socialism that opposes the government, religion, and private ownership. It arose from Mikhail Bakunin's philosophy. Bakunin recommended that employees be compensated according to their input and that the means of production be collectivised. In contrast, Marxist Socialism pushed for the state to play a much larger role in overseeing the means and results of labour. 2. Utopian socialism 65 It's based on Henri de Saint- Simon's, Charles Fourier's, and Robert Owen's work. CU IDOL SELF LEARNING MATERIAL (SLM)

Utopian socialism is a sort of ethical socialism that demands members of the community to adhere to particular ethical standards. The standard economic concept of rational choice — the idea that individuals aim to maximise their particular benefit – is challenged by utopian socialism. In a socialist utopia, It is based on the work of Henri de Saint-Simon, Charles Fourier, and Robert Owen. Utopian socialism is a type of ethical socialism which requires a certain ethics of those living in the community. Utopian socialism is a challenge to the conventional economic model of rational choice – the idea that individuals seek to maximise their individual utility. Individuals will be able to set their own interests aside to consider the general good under utopian socialism. Aspects of Utopian-socialism No state ownership of means of production Advocates co-operation between owners and workers – rather than adversarial workers vs capitalist /trade unions Local decentralization of decision-making process. Market forces harnessed but emphasis on considering common good rather than selfish ends 3. State-Communism The Communist State acquires control over the means of production and decides what to produce under state communism (e.g. Marxist-Leninist). What is the best way to produce? and who is it for? The Soviet Union and Eastern European countries are two examples. There is a significant degree of centralisation under state communism, with central committees setting production targets and local authorities responsible for reaching them. States with a centrally planned economy have frequently exercised significant political power. The Soviet Union experienced periods of significant industrial expansion and economic growth in the 1930s and 1940s. The system, on the other hand, became increasingly bureaucratic, wasteful, and devoid of incentives. The Soviet Union's economic system was progressively damaged by the conclusion of the Cold War, with serious shortages. Aspects of state communism  Political control/censorship  State ownership of all major industries  Production decided by central committees  Prices set by government committees 66 CU IDOL SELF LEARNING MATERIAL (SLM)

 Limited or no role for private enterprise and free-market forces 4. Democratic socialism Democratic socialism differs from state communism in that the state does not have absolute authority and the political system is still democratic. Democratic socialism is related with Western European Socialist parties. They often advocate for a mixed economy, in which critical industries such as coal, power, water, and gas are owned by the government, but the remainder of the economy is run by private industry. Democratic socialism supports a progressive tax system to redistribute money from the wealthy to the poor via the welfare state. Democratic socialism is frequently connected with the Nordic countries, where the government absorbs about half of GDP but there is also a vibrant market sector that provides a good standard of living. Aspects of Democratic socialism Advocates nationalization of key industries (often the natural monopolies, like electricity, water) Prices set by the market mechanism, except public goods, such as health and education. Provision of a welfare state to provide income redistribution Support for trade unions in wage bargaining Use of minimum wages and universal income to raise low-income wages Progressive tax and provision of public services. For example, marginal income tax rates of 70%. Tax on wealth 5. Social democratic socialism There is a stronger openness to use market forces under social democratic socialism. Certain state-owned industries, for example, may be privatised under social democracy because they are more efficient. However, the tax system might be utilised to redistribute large earnings from privatised businesses. More right-wing socialist parties, such as the Labour Party under Tony Blair, are associated with social democracy. For instance, under Labour, ‘windfall tax’ was implemented and resulted in high profits wherein renationalise of privatised industries was not allowed. Aspects of social democratic socialism 67 Greater willingness to harness market-forces No commitment to nationalization of industries. CU IDOL SELF LEARNING MATERIAL (SLM)

Use of minimum wages and universal income to raise low-income wages Socialist aims achieved through progressive tax and provision of public services 6. Libertarian socialism Libertarian socialism opposes the involvement of a powerful state in economic and labour market administration. Local collectives joining together voluntarily to promote socialist ideas of cooperation is preferred instead. 7. Christian socialism Christian socialism strives to provide socialism an ethical foundation. It offers redistribution and public services like health and education a Christian motivation. It also maintains political and economic liberty while avoiding Communism's excesses. 8. Market Communism e.g., China The economy mixture of free-market enterprise and state control Communist party is a one-party political state e.g., China 4.3.3 Mixed Economy A mixed economy combines the best features of capitalism and socialism. Thus, mixed economy has some elements of both free enterprise or capitalist economy as well as a government controlled socialist economy. The public and private sectors co-exist in mixed economies. 68 CU IDOL SELF LEARNING MATERIAL (SLM)

Fig 4.4: Features of Mixed Economic System The main characteristics of a mixed economy are as follows: (i) Co-existence of public and private sectors: The private sector consists of production units that are owned privately and work on the basis of profit motive. The public sector consists of production units owned by the government and works on the basis of social welfare. The areas of economic activities of each sector are generally demarcated. Government uses its various policies e.g., licensing policy, taxation policy, price policy, monetary policy and fiscal policy to control and regulate the private sector. (ii) Individual Freedom: Individuals take up economic activities to maximize their personal income. They are free to choose any occupation and consume as per their choice. But producers are not given the freedom to exploit consumers and laborers. Government puts some restrictions keeping in mind the welfare of the people. For instance, government may put restrictions on the production and consumption of harmful goods. But within rules, regulations and restrictions imposed by the government, for the welfare of the society the private sector enjoys complete freedom. 69 CU IDOL SELF LEARNING MATERIAL (SLM)

(iii) Economic Planning: The government prepares long-term plans and decides the roles to be played by the private and public sectors in the development of the economy. The public sector is under direct control of the government as such production targets and plans are formulated for them directly. The private sector is provided encouragement, incentives, support and subsidies to work as per national priorities. (iv) Price Mechanism: Prices play a significant role in the allocation of resources. For some sectors the policy of administered prices is adopted. Government also provides price subsidies to help the target group. The aim of the government is to maximize the welfare of the masses. For those who cannot afford to purchase the goods at market prices, government makes the goods available either free of cost or at below market (subsidized) prices. Thus in a mixed economy people at large enjoy individual freedom and government support to protect the interests of weaker sections of the society. Indian economy is considered a mixed economy as it has well defined areas for functioning of public and private sectors and economic planning. Even countries such as USA, UK, etc. which were known as capitalistic countries are also called mixed economies now because of active role of their government in economic development. Advantages of mixed economies Incentives to be productive. Private companies may control the majority of business and industry. Because private enterprises have a monetary motivation to minimize expenses and be inventive, they are more efficient than government-controlled firms. Prevents the government from interfering. In contrast to command economies, mixed economies can lower the amount of government regulation and interference. Reduces market failure. Government regulation is necessary in case of Market Regulation. This can include: • Regulation of monopoly power misuse, such as preventing mergers and prohibiting overly high prices. • Goods having negative externalities, such as pollution, are taxed and regulated. • Subsidies are government support for goods and services that are underutilized in a free market. Public goods, such as police and national defense, as well as merit goods, such as education and healthcare, can be included. A degree of equality. A mixed economy can help to increase equity and provide a \"safety net\" to keep people out of poverty. A mixed economy, on the other hand, can allow people to reap the financial benefits of hard labour and entrepreneurship. Macroeconomic stability. Governments can undertake strategies to maintain macroeconomic stability, such as expanding fiscal policy during a recession. Even libertarians who oppose government interference feel that private property and government- provided peace and order require legal protection. 70 CU IDOL SELF LEARNING MATERIAL (SLM)

Disadvantages of mixed economies How much should the government intervene? It's difficult to tell how much governments should act; for example, discretionary fiscal policy could lead to other issues like government indebtedness. Is there too much disparity? Socialists criticize mixed economies for allowing too much market forces to operate, resulting in inequality and poor resource allocation. Failure of the government. Free-market economists criticize mixed economies for permitting excessive government interference. Governments, according to libertarians, are terrible managers of the economy because they are always affected. 4.4 TYPES OF ECONOMICS ON THE BASIS OF LEVEL OF DEVELOPMENT On the basis of level of development economies can be classified in two categories: (i) Developed economy (ii) Developing economy. The countries are labeled developed or rich and developing or poor on the basis of real national and per capita income and standard of living of its population. Developed countries have higher national and per-capita income, high rate of capital formation i.e. high savings and investment. They have highly educated human resources, better civic facilities, health and sanitation facilities, low birth rate, low death rate, low infant mortality, developed industrial and social infrastructures and a strong financial and capital market. In short, developed countries have high standard of living. Developing countries are low on the ladder of development. They are sometimes also called underdeveloped, backward or poor countries. But economists prefer to call them developing countries because it gives a sense of dynamism. The national and per capita income is low in these countries. They have backward agricultural and industrial sectors with low savings, investment and capital formation. Although these countries have export earnings but generally, they export primary agricultural products. In short, they have low standard of living and poor health and sanitation, high infant mortality, high birth and death rates and poor infrastructure. Thus, economic development depends on many factors and has different meanings. 4.5 SUMMARY  An economic system is the socio-economic and political framework within which an economy function.  A free-enterprise economy also known also as capitalism, market-driven economy, Laissez-Faire and free-market economy, postulates that free and unfettered trade help 71 CU IDOL SELF LEARNING MATERIAL (SLM)

economies grow to their fullest potential.  Private property is the most important feature of capitalism. Other characteristics include consumer sovereignty, freedom of enterprise, free play of enlightened self- interest of individuals and profit motive being the mainspring of economic activity and the engine of progress.  A socialistic economy is one where conscious and deliberate choice of economic priorities is made by some public authorities. Some features of a planned economy are: a central planning authority, pre-determined and well-defined objectives, fixation of targets, administration of controls and growing role of the public sector.  Socialism is founded on the principle that resources belong to the entire society and they should be owned by all members of the society represented by the State. In such an economy, all the means of production including landed property are vested in the hands of the State. Economic development is carried out through centralized planning. It is a public sector oriented economic system.  A mixed economy incorporates the merits of both socialism and capitalism while eliminating the pitfalls found in both of them. In such an economy, both public and private sectors coexist  Balance between the private and the public sectors has been achieved by adopting certain policies that permitted both the sectors to play their role in a well-planned manner; formulation of the Industrial Policy Resolution of 1948 and 1956, and also the industries (Development and Regulations) Act. 4.6 KEYWORDS  Price mechanism refers to the system where the forces of demand and supply determine the prices of commodities and the changes therein  Economic system: is the socio-economic and political framework within which an economy functions.  Laissez-faire system: The driving principle behind laissez-faire, a French term that translates to \"leave alone\" (literally, \"let you do\"), is that the less the government is involved in the economy, the better off business will be, and by extension, society as a whole.  A socialistic economy is one where conscious and deliberate choice of economic priorities is made by some public authorities.  Co-exist - exist at the same time or in the same place. 72 CU IDOL SELF LEARNING MATERIAL (SLM)

4.7 LEARNING ACTIVITY 1. Why Class Conflict is included as a feature of Capitalist Economy? _______________________________________________________________________ ________________________________________________________________________ 2. Equality of opportunity is an important feature of Socialist Economy. Discuss your views. _______________________________________________________________________ ________________________________________________________________________ 4.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. State the salient features of an economy. 2. Explain the concept of Economic system. 3. Enlist the demerits associated with Capitalist Economy. 4. Define Socialist Economy. 5. Why Government Control and Regulation of the Private Sector is necessary in Mixed Economy? Long Questions 1. State and explain the advantages of Capitalist Economy 2. Explain on the basis of level of development how economies are classified? 3. Why Public Sector is emphasized in Socialist Economy? 4. Discuss the Demerits of Socialist Economy. 5. Brief about the features of Indian Mixed Economy. B. Multiple Choice Questions 1. The ______________plays an important role of coordinating agent in Capitalist Economy. a. Price system b. Legal system c. Judicial system d. Joint FDI 73 CU IDOL SELF LEARNING MATERIAL (SLM)

2. The prices of products and services are also determined by the interaction of consumers through market forces. This feature is known as ______________ a. Private Property b. Consumer Sovereignty c. Enlightened Self –interest d. Profit Motive 3. Identify the feature of Socialist Economy a. Private Property b. Co-existence of public and private sectors c. Public ownership of property d. Absence of government interference 4. What believes in a secular State? a. Capitalist Economy b. Mixed Economy c. Market Economy d. Socialism 5. In Mixed economy both public and private sectors ___________ a. Coexist b. does not exist together c. are parallel in nature d. are joint Answers 1-a, 2-b, 3-c, 4-d, 5-a 4.9 REFERENCES Text Books:  Francis Cherunilam , Business and Environment, Text and Cases, [Himalaya 74 CU IDOL SELF LEARNING MATERIAL (SLM)

Publishing House],  C. Fernando, Business Environment Kindle Edition, Pearson  K.Aswathappa, Essentials Of Business Environment, Himalaya Publishing House  SHAIKH SALEEM, BUSINESS ENVIRONMENT, Pearson  Ian Worthington, Chris Britton, The Business Environment, Financial Times/ Prentice Hall.  Justin Paul, “Business Environment”, Tata McGraw Hill Publications  P.K.Ghosh : “Business Environment”, Sultan Chand Publishers, New Delhi Reference Books:  Engineering Economic-Dr. Rajan Mishra by University Science Press  The Gazette of India, Ministry of Law and Justice, New Delhi. No.311, June’16, 2006.  Morrison J, The International Business Environment, Palgrave  MISHRA AND PURI, Indian Economy, Himalaya Publishing House, New Delhi  Business Environment Raj Aggarwal Excel Books, Delhi  Strategic Planning for Corporate Ramaswamy V McMillan, New Delhi  Dahl Modern political analysis. Englewood Cliffs, N.J: Prentice-Hall. Open Text Source:  Dhamija, Dr. Ashok (2009). Prevention of Corruption Act. LexisNexis India. p. 2049. ISBN 9788180385926.  Subrata K. Mitra and V.B. Singh. 1999. Democracy and Social Change in India: A Cross-Sectional Analysis of the National Electorate. New Delhi: Sage Publications. ISBN 81-7036-809-X (India HB) ISBN 0-7619-9344-4 (U.S. HB).  Bakshi; P M (2010). Constitution Of India, 10/e. Universal Law Publishing Company Limited. pp. 48–.ISBN 978-81-7534-840-0.  International Journal of Scientific and Research Publications, Volume 2, Issue 12, December 2012  www.yourarticlelibrary.com  https://courses.lumenlearning.com/ 75 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT 5:DIFFERENT TYPES OF ECONOMIC 76 POLICIES STRUCTURE 5.0 Learning Objectives 5.1 Introduction 5.2 Monetary Policy 5.2.1Concept and Meaning 5.2.2 Objectives of Monetary Policy 5.2.3 Measures of Money 5.3 Monetary Policy and Money Supply 5.4 Instruments of Monetary Policy 5.4.1 General Methods 5.4.2 Selective Methods 5.5 Impact of Monetary Policy 5.6 Fiscal Policy 5.6.1 Concept and meaning 5.6.2 Objectives of Fiscal Policy 5.6.3 Role of Fiscal Policy 5.7Difference between Monetary and Fiscal Policy 5.8 Techniques of Fiscal Policy 5.8.1 Taxation Policy (Tax Structure of Government of India) 5.8.2 Public Expenditure Policy 5.8.3 Public Debt Policy 5.8.4 Deficit Financing Policy 5.9 Fiscal Policy Reforms Introduced by the Government of India 5.10 Industrial Policy Resolution, 1948 5.11 Summary 5.12 Keywords 5.13 Learning Activity CU IDOL SELF LEARNING MATERIAL (SLM)

5.14 Unit End Questions 5.15 References 5.0 LEARNING OBJECTIVES After studying this Unit, you will be able to  Explain the Objectives of Monetary Policy.  Illustrate the relationship between Monetary and Money Supply  Analyze the General and Selective instruments of Monetary Policy  Outline the impact of Monetary Policy  Explain the Objectives and Role of Fiscal Policy.  Compare the features of Monetary and Fiscal Policy  Analyze the Techniques of Fiscal Policy  Describe the importance of Reforms in Fiscal Policy 5.1 INTRODUCTION Economic system needs system to monitors its functioning. Such control mechanism is implemented with the help of fiscal and monetary policy. Fiscal policy is defined on the basis of revenue generated by the government while RBI in India (Central Bank) administer the monetary policy. he main objective of these policies is to either increase the GDP (gross domestic product) and economic development which is termed as expansionary initiatives, or in case they are meant to deal with inflation then they are termed as contractionary initiatives. Government extends all support to revive the down fall of the economy. Steps like government can opt for increase in spending to increase the demand when demand is low. Government can decrease the tax amount to increase the spending’s. To achieve economic development, price stability and full employment, Government always deceive the level of aggregate demand. RBI approve the implementation of quantitative or qualitative measures to monitor the money supply in the country. Generally, such control is executed by changing CRR (Cash Reserve Ratio) and SLR (Statutory Liquidity Ratio) that administer the operations and disposable funds of financial institutions to influence the economic growth, unemployment, inflation and rates of exchange of currency. Economic development and balance in the economy is achieved by executing the measures of monetary and fiscal policy together. 77 CU IDOL SELF LEARNING MATERIAL (SLM)

5.2 MONETARY POLICY The main purpose of implementing Monetary policy is to accelerate the economic development and stabilize price and wages by modifying the money supply and credit by changing the interest rates. Monetary policy is one of the important dimensions of the country’s national bank. The trends of inflation traced during after World War II has emphasized the importance of monetary policy. If money supply is modified, then inflation can be controlled. RBI acts as the monetary supremacy of India and thus handles monetary policy. Every year, in April, Reserve Bank of India declares Monetary Policy which is followed by quarterly reviews in July, October and January. But RBI has power to declare any modifications any time. There are two contributing aspects of monetary policy as: PART A: development concerned with macroeconomic and monetary aspect PART B: Records of all measures implemented earlier with new measures initiated. The important elements of monetary policy are financial markets stability, interest rates, credit delivery, etc. Monetary policy also manages the availability of financial resources for regulating economic and financial growth. Monetary policy has widened its scope and covers various aspects like availability of credit to efficient sector, encouragement of investment and trade and price stability. 5.2.1 Concept and Meaning Monetary policy is all about money supply, economic stability and building trust in the currency. To deal the unemployment issues in recession, measures of expansionary Monetary policy are implemented to reduce the interest rate for providing growth opportunity to the business. Contractionary Monetary policy is meant for decreasing the growth of money supply or even narrow it for avoiding deterioration of asset values during inflation. Monetary policy monitors controls (i) the supply of money, (ii) availability of money, and (iii) cost of money. It is concerned with the correlation of total supply of money and the interest rate of borrowing the money, i.e., Credit. When Monopoly of issuance comes into play and currency of the country falls under its purview or issuance of currency’s are with banks which have alliances with Central bank, the RBI has the power to influence the interest rates and modify the money supply in order to maintain economic stability. Well-known definitions of Monetary Policy are as follows: 78 CU IDOL SELF LEARNING MATERIAL (SLM)

According to Prof. Harry Johnson, “A policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy is a monetary policy.” G.K. Shaw defines it as “any conscious action undertaken by the monetary authorities to change the quantity, availability or cost of money.” General Definitions are: Broader economic objectives termed as Macro-economic objective of the country like development and liquidity; inflation control is possible by implementing various measures of monetary policy which is govern by central bank. Interest rate is directly proportional to the money supply growth and size in the economy of the country. Three important instruments of monetary policy that are applied through RBI is Selling and buying of national debt Change introduced in credit restrictions Reserves are modified to introduce alteration of interest rates. Money supply is the core of monetary policy which includes credit, cash, checks, and money market and mutual funds. Out of these, the most significant is credit, that includes loans, bonds, mortgages, and other agreements to repay. Monetary policy defines the administrative framework of the central bank of the country. It plays very essential part in controlling aggregate demand and inflation. In India, monetary policy of the Reserve Bank of India is a critical measure to achieve balanced development of different sectors of the economy. 5.2.2 Objectives of Monetary Policy: The important objectives of monetary policy are as follows: 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. Regulation, Supervision and Development of Financial Stability: Financial stability means the ability of the economy to absorb shocks and maintain confidence in financial system. Threats to financial stability can come from internal and external shocks. Such shocks can destabilize the country’s financial system. Thus, greater importance is being given to RBI’s role in maintaining confidence in financial system through proper regulation and controls, without sacrificing the objective of growth. Therefore, RBI is focusing on regulation, supervision and development of financial system. 79 CU IDOL SELF LEARNING MATERIAL (SLM)

3. Price Stability: All the economics suffer from inflation and deflation. It can also be called as Price Instability. Both 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'. 4. 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. 5. Balance of Payment: Many developing countries like India suffer 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 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. 6. 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. 7. Promoting Priority Sector: Priority sector includes agriculture, export and small scale enterprises and weaker section of population. RBI with the help of bank provides timely and adequately credit at affordable cost of weaker sections and low income groups. RBI, along with NABARD, is focusing on microfinance through the promotion of Self Help groups and other institutions. 8. Encouraging Savings and Investments: RBI by offering attractive interest rates encourages savings in the economy. A high rate of saving promotes investment. Thus the monetary management by influencing rates of interest can influence saving mobilization in the country. 9. Regulation of NBFIs: Non – Banking Financial Institutions (NBFIs), like UTI, IDBI and IFCI plays an important role in deployment of credit and mobilization of savings. RBI does not have any direct control on the functioning of such institutions. However it can indirectly affects the policies and functions of NBFIs through its monetary policy 80 CU IDOL SELF LEARNING MATERIAL (SLM)

10. 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 11. Equal Income Distribution: Many economists used to justify the role of the fiscal policy is maintaining economic equality. However in recent 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. 12. Improvement in Standard of Living: It is also the major objective of the monetary policy that it should improve the quality of life in the country. 5.2.3 Measures of Money Money Supply: The supply of money means the total stock of money (paper notes, coins and demand deposits of bank) in circulation which is held by the public at any particular point of time. Briefly, money supply is the stock of money in circulation on a specific day. Thus two components of money supply are: i. Currency (Paper notes and coins) ii. Demand deposits of commercial banks Supply of money is only that part of total stock of money which is held by the public at a particular point of time. In other words, money held by its users (and not producers) in spendable form at a point of time is termed as money supply. The stock of money held by government and the banking system are not included because they are suppliers or producers of money and cash balances held by them are not in actual circulation. In short, money supply includes currency held by public and net demand deposits in banks. Sources of Money Supply: 1. Government (which issues one-rupee notes and all other coins) 2. RBI (which issues paper currency) 3. Commercial banks (which create credit on the basis of demand deposits) Measures of Money Supply: 81 CU IDOL SELF LEARNING MATERIAL (SLM)

There are four measures of money supply in India which are denoted by M1, M2, M3 and M4. This classification was introduced by the Reserve Bank of India (RBI) in April 1977. Prior to this till March 1968, the RBI published only one measure of the money supply, M or defined as currency and demand deposits with the public. This was in keeping with the traditional and Keynesian views of the narrow measure of the money supply. From April 1968, the RBI also started publishing another measure of the money supply which it called Aggregate Monetary Resources (AMR). This included M1 plus time deposits of banks held by the public. This was a broad measure of money supply which was in line with Friedman’s view. But since April 1977, the RBI has been publishing data on four measures of the money supply which are discussed as under. Out of four alternative measures of money supply i.e. M1, M2, M3 and M4, M1 is the most commonly used measure of money supply because components are regarded most liquid assets. Each measure is briefly explained below: M1. The first measure of money supply, M1 consists of: M1 = C + DD + OD (i) C- Currency with the public which includes notes and coins of all denominations in circulation excluding cash on hand with banks: (ii) DD-Demand deposits are deposits which can be withdrawn at any time by the account holders. Current account deposits are included in demand deposits. But savings account deposits are not included in DD because certain conditions are imposed on the amount of withdrawals and number of withdrawals. Demand deposits with commercial and cooperative banks, excluding inter-bank deposits; and (iii) OD-‘Other deposits’ with RBI which include current deposits of foreign central banks, financial institutions and quasi-financial institutions such as IDBI, IFCI, etc., other than of banks, IMF, IBRD, etc. The RBI characterizes as narrow money. M2. The second measure of money supply is M2 which consists of M1plus post office savings bank deposits. Since savings bank deposits of commercial and cooperative banks are included in the money supply, it is essential to include post office savings bank deposits. The majority of people in rural and urban India have preference for post office deposits from the safety viewpoint than bank deposits. M2 = M1 + saving deposits with Post Office Saving Banks 82 CU IDOL SELF LEARNING MATERIAL (SLM)

M3. The third measure of money supply in India is M3, which consists of M1, plus time deposits with commercial and cooperative banks, excluding interbank time deposits. The RBI calls M3 as broad money. M3= M1 + Net Time-deposits of Banks M4. The fourth measure of money supply is M4 which consists of M3plus total post office deposits comprising time deposits and demand deposits as well. This is the broadest measure of money supply. M4 = M3 + Total deposits with Post Office Saving Organization (excluding NSC) In fact, a great deal of debate is still going on as to what constitutes money supply. Savings deposits of post offices are not a part of money supply because they do not serve as medium of exchange due to lack of cheque facility. Similarly, fixed deposits in commercial banks are not counted as money. Therefore, M1 and M2 may be treated as measures of narrow money whereas M3and M4 as measures of broad money. Of the four inter-related measures of money supply for which the RBI publishes data, it is M3 which is of special significance. It is M3 which is taken into account in formulating macroeconomic objectives of the economy every year. Since M1 is narrow money and includes only demand deposits of banks along-with currency held by the public, it overlooks the importance of time deposits in policy making. That is why, the RBI prefers M3 which includes total deposits of banks and currency with the public in credit budgeting for its credit policy. It is on the estimates of increase in M3 that the effects of money supply on prices and growth of national income are estimated. In fact is an empirical measure of money supply in India, as is the practice in developed countries. The Chakravarty Committee also recommended the use of M3for monetary targeting without any reason. In practice, M1 is widely used as measure of money supply which is also called aggregate monetary resources of the society. All the above four measures represent different degrees of liquidity, with M4 being the most liquid and M4 is being the least liquid. It may be noted that liquidity means ability to convert an asset into money quickly and without loss of value. Liquidity and Ranking: Name Type Liquidity M1 Narrow Money Highest M2 Narrow Money Less than M1 M3 Broad Money Less than M2 M4 Broad Money Lowest Liquidity 83 CU IDOL SELF LEARNING MATERIAL (SLM)

5.3 MONETARY POLICY AND MONEY SUPPLY In the context of developing economies like India, monetary policy acquires a wider role and it has to be designed to meet the particular requirements of the economy. It stimulates or discourages spending on goods and services and, thus, influences economic activities and prices by regulating the supply of money, and the cost and availability of credit to producers and consumers in the economy. Households and business units make spending and investment decisions based upon current and expected future monetary policy actions. The various sectors of the economy respond in different ways, depending on the extent to which they are borrowers or lenders and the importance and relative availability of credit to the sector. By affecting the demand side of the economy, monetary policy tries to damp or perhaps even eliminate business. Fluctuations - economy-wide recessions and booms arising from fluctuations in aggregate demand. In India, the three major objectives of economic policy are growth, social justice (equitable distribution of income and wealth) and price stability. Of these, price stability is perhaps the one that can be pursued most effectively by the monetary authorities of the country. The monetary policy of an economy operates through three important instruments, viz., and the regulation of money supply, control over aggregate credit and the interest rate policy. In pre- reform period, given the largely underdeveloped state of financial system, regulated nature of financial markets and plan priorities, the RBI often resorted to the direct instruments of monetary policy like CRR, SLR and interest rate for allocating credit and regulating money supply in the economy. Gradual liberalization and globalization of the economy, strengthening and development of the financial system, restrictions on the automatic monetization of fiscal deficit and various other changes in the economy had made it possible for the RBI to operate with the indirect instruments of monetary policy such as bank rate, repo rate and OMOs (open market operations). Accordingly, there has been a distinct shift in the monetary policy framework and operating procedures from direct instruments of monetary control to market based indirect instruments in the recent years. The thrust has been to provide the market mechanism a greater role in the economy, to provide the banks more operational flexibility and to bring the allocative efficiency in the economy. In the recent years, the thrust of the monetary policy was to reduce the annual inflation rate. Since the year 2009 the inflation in India has crossed historical records and reached to unprecedented levels, and lying in the range of 9 - 14 %. The monetary authorities are striving hard to curb the inflation by adopting several monetary policy measures, the important amongst which are changes in CRR, repo and reverse repo rate, which directly influence the money supply in the market with immediate effect without creating any distortions in the economy. That is the reason, they are perceived to be the most appropriate by the monetary authorities to curb the existing inflation, and hence changed 16 times during the year 2009 to 2011. Monetary policy which aims at changing the money supply in order to achieve the national economic goals requires the following conditions to be satisfied. 84 CU IDOL SELF LEARNING MATERIAL (SLM)

1. A close correspondence must exist between the theoretical definition of money and the empirical (measurable) definition of money. 2. The monetary authority must be able to control the empirically defined money supply and to meet the intermediate monetary targets (such as monetary growth rate, interest rate etc) with the help of the instruments such as bank rate, open market operations etc. 3. The empirical definition of money must be closely and predictably related to ultimate national goals. Achievement of monetary growth rate or interest rate targets is not enough. Such achievement must also change economic variables in the desired manner. Monetary policy requires a meaningful and practical definition of money. Since changes in the supply of money affect important economic variables, they can also influence the attainment of ultimate national economic goals. The goals of internal price stability, international balance of payments equilibrium, economic growth, high employment are all directly or indirectly affected by the changes in money supply. Variations in currency are not possible except over comparatively long period. Thus, changes in currency do not play an important role in the formulation of monetary policy. 5.4 INSTRUMENTS OF MONETARY POLICY: The various credit policy or monetary instruments used by a Central Bank of Country can be divided as follows: Monetary Instruments/ Methods of Credit Control General Methods /Quantitative Selective Methods /Qualitative Methods Methods  Bank Rate Policy  Marginal Requirements  Open Market Operations  Variable Reserves Ratios  Consumer Credit o Cash Reserves Ratio (CRR) Regulation o Statutory Reserve Ratio  Publicity  Credit Rationing (SLR)  Moral Suasion  Control through Directives  Direct Actions 85 CU IDOL SELF LEARNING MATERIAL (SLM)

Fig 5.1: Instruments of Monetary Policy The general methods affect the total quantity of credit or economy in general. The selective methods on the other hand, affect certain selected sectors or certain qualitative distinctions are made between different sectors and segments of the economy; and selectivity is applied in regulating the flow of credit. The Reserve Bank of India (RBI), Act confers on the Banks the usual powers available to central banks generally and the Banking Regulation Act provides special powers of regulation for the operations of commercial and co-operative banks, which formed the statutory basis for the credit regulation in India. 5.4.1 General Credit Controls/ Quantitative Methods: In this method, it is important that the three instruments namely Bank rate policy, Open market operations and Variable reserves ratios are inter-related and operates in co-ordination. All the three instruments affect the bank reserves. Open Market Operation and Reserve Ratios directly affect the reserve base, while Bank Rate Policy affects indirectly by variations in the cost of acquiring the reserves. The use of any one instrument rather than another at any point is determined by the nature of the situation and the range of influence it is desired to wield as well as the rapidity with which the change is required to be brought about. The effects of Bank Rate changes are not confined to the banking system and the short-term money market; it has wide repercussions on the economy as a whole. Open market Operations are suitable for carrying out day-to-day adjustments on even smaller scale. A change in Reserve Ratios produces an impact at once and affects the banks generally. i. Bank Rate Policy: The Bank Rate Policy is a very important technique used in the monetary policy for influencing the volume or the quantity of the credit in a country. The bank rate refers to rate at which the central bank (i.e. RBI) rediscounts bills and prepares of commercial banks or provides advance to commercial banks against approved securities. It is \"the standard rate at which the bank is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchase under the RBI Act\". The Bank Rate affects the actual availability and the cost of the credit. Any change in the bank rate necessarily brings out a resultant change in the cost of credit available to commercial banks. If the RBI increases the bank rate than the volume of commercial banks borrowing from the RBI gets reduced. It deters banks from further credit expansion as it becomes a more costly affair. Even with increased bank rate the actual interest rates for a short term lending go up checking the credit expansion. On the other hand, if the RBI reduces the bank rate, borrowing for commercial banks will be easy and cheaper. This will boost the credit creation. As per the Bank rate theory, an increase in the Bank rate reduces the extent of borrowings from the money market, the level of 86 CU IDOL SELF LEARNING MATERIAL (SLM)

inventory holding, investment, employment and prices. A reduction in the Discount Rate has the opposite effects. The Central bank, may therefore, attempt to contain an inflationary situation by raising the Bank Rate and fight a depression or recession by lowering it. Thus any change in the bank rate is normally associated with the resulting changes in the lending rate and in the market rate of interest. However, the efficiency of the bank rate as a tool of monetary policy depends on existing banking network, interest elasticity of investment demand, size and strength of the money market, international flow of funds, etc. The importance of Bank rates lies in the fact that it acts as a pace-setter to all the other rates of interests. ii. Open Market Operation (OMO): The open market operation refers to the purchase and/or sale of short term and long term securities by the RBI in the open market. This is very effective and popular instrument of the monetary policy. The OMO is used to wipe out shortage of money in the money market, to influence the term and structure of the interest rate and to stabilize the market for government securities, etc. It is important to understand the working of the OMO. If the RBI sells securities in an open market, commercial banks and private individuals buy it. This reduces the existing money supply as money gets transferred from commercial banks to the RBI. Contrary to this when the RBI buys the securities from commercial banks in the open market, commercial banks sell it and get back the money they had invested in them. Obviously the stock of money in the economy increases. This way when the RBI enters in the OMO transactions, the actual stock of money gets changed. Normally during the inflation period in order to reduce the purchasing power, the RBI sells securities and during the recession or depression phase it buys securities and makes more money available in the economy through the banking system. Thus under OMO there is continuous buying and selling of securities taking place leading to changes in the availability of credit in an economy. However there are certain limitations that affect OMO viz; underdeveloped securities market, excess reserves with commercial banks, indebtedness of commercial banks, etc. iii. Variations in the Reserve Ratios: The Commercial Banks have to keep a certain proportion of their total assets in the form of Cash Reserves. Some part of these cash reserves are their total assets in the form of cash. Apart of these cash reserves are also to be kept with the RBI for the purpose of maintaining liquidity and controlling credit in an economy. These reserve ratios are named as Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR). The CRR refers to some percentage of commercial bank's net demand and time liabilities which commercial banks have to maintain with the central bank and SLR refers to some percent of reserves to be maintained in the form of gold or foreign securities. In India the CRR by law remains in between 3-15 percent while the SLR remains in between 25-40 percent of bank reserves. Any change in the VRR (i.e. CRR + SLR) brings out a change in commercial banks reserves 87 CU IDOL SELF LEARNING MATERIAL (SLM)

positions. Thus by varying VRR commercial banks’ lending capacity can be affected. Changes in the VRR helps in bringing changes in the cash reserves of commercial banks and thus it can affect the banks credit creation multiplier. RBI increases VRR during the inflation to reduce the purchasing power and credit creation. But during the recession or depression it lowers the VRR making more cash reserves available for credit expansion. Cash Reserve Ratio (CRR): It is defined as that portion of total deposits which a commercial bank is required to keep with the RBI in the form of cash reserves. In 2013, it was 4.0% which implies that every commercial bank has to keep 4% of its total deposits with the RBI. In a situation of excess demand, RBI raises the CRR. This will reduce the cash deposits left with commercial banks to be loaned out. This is another method to control the availability of credit. Statutory Liquidity Ratio (SLR): It is defined as that portion of total deposits which a commercial bank has to keep with itself in the form of liquid assets. In a situation of excess demand, RBI raises the SLR. The result is the reduction in surplus cash reserves of commercial banks which can be offered for credit. This will discourage credit in an economy. The SLR in India, at present is 21.50 % for entire net demand and time liabilities of scheduled commercial banks. 5.4.2 Selective Credit Regulations / Qualitative Methods: These tools are not directed towards the quality of credit or the use of the credit. They are used for discriminating between different uses of credit. It can be discrimination favoring export over import or essential over non-essential credit supply. This method can have influence over the lender and borrower of the credit. It refers to regulation of credit for specific purposes or branches of economic activity. It is associated with the distribution or direction of available credit supplies. They are designed specifically to curb excesses in selected area without affecting other types of credit. They attempt to achieve a reasonable stabilization of the prices of particular commodities on the demand side, by regulating the availability of bank credit for purchasing and holding them. It should be however noted that prices are determined by the interaction of demand and supply, and if the supply is substantially short then moderate price rise strategy is used instead of arresting the basic trend. In India, such controls have been used to prevent speculative hoarding of commodities like food grains and essential raw materials and also check an undue rise in their prices. The selective credit controls are treated as useful supplement to general credit regulations as the effectiveness of both the method get increased together. It comprises of following instruments: i. Fixing Margin Requirements: The margin refers to the \"proportion of the loan amount which is not financed by the bank\". Or in other words, it is that part of a loan which a borrower has to raise in order to get finance for his purpose. A change in a margin implies a change in the loan size. This method is used 88 CU IDOL SELF LEARNING MATERIAL (SLM)

to encourage credit supply for the needy sector and discourage it for other non-necessary sectors. This can be done by increasing margin for the non-necessary sectors and by reducing it for other needy sectors. Example: - If the RBI feels that more credit supply should be allocated to agriculture sector, then it will reduce the margin and even 85-90 percent loan can be given. ii. Consumer Credit Regulation: Under this method, consumer credit supply is regulated through hire-purchase and instalments sale of consumer goods. Under this method the down payment, instalments amount, loan duration, etc. is fixed in advance. This can help in checking the credit use and then inflation in a country. iii. Publicity: This is yet another method of selective credit control. Through its Central Bank (RBI) publishes various reports stating what is good and what is bad in the system. This published information can help commercial banks to direct credit supply in the desired sectors. Through its weekly and monthly bulletins, the information is made public and banks can use it for attaining goals of monetary policy. iv. Credit Rationing: Central Bank fixes credit amount to be granted. Credit is rationed by limiting the amount available for each commercial bank. This method controls even bill rediscounting. For certain purpose, upper limit of credit can be fixed and banks are told to stick to this limit. This can help in lowering banks credit exposure to unwanted sectors. v. Moral Suasion: It implies to pressure exerted by the RBI on the Indian banking system without any strict action for compliance of the rules. It is a suggestion to banks. It helps in restraining credit during inflationary periods. Commercial banks are informed about the expectations of the central bank through a monetary policy. Under moral suasion central banks can issue directives, guidelines and suggestions for commercial banks regarding reducing credit supply for speculative purposes vi. Control through Directives: Under this method the central bank issue frequent directives to commercial banks. These directives guide commercial banks in framing their lending policy. Through a directive the central bank can influence credit structures, supply of credit to certain limit for a specific purpose. The RBI issues directives to commercial banks for not lending loans to speculative sector such as securities, etc. beyond certain limit. vii. Direct Action: 89 CU IDOL SELF LEARNING MATERIAL (SLM)

Under this method the RBI can impose an action against a bank. If certain banks are not adhering to the RBI's directives, the RBI may refuse to rediscount their bills and securities. Secondly, RBI may refuse credit supply to those banks whose borrowings are in excess to their capital. Central bank can penalize a bank by changing some rates. At last, it can even put a ban on a particular bank if it does not follow its directives and work against the objectives of the monetary policy. These are various selective instruments of the monetary policy. However, the success of these tools is limited by the availability of alternative sources of credit in economy, working of the Non-Banking Financial Institutions (NBFIs), profit motive of commercial banks and undemocratic nature off these tools. But a right mix of both the general and selective tools of monetary policy can give the desired results. 5.5 IMPACT OF MONETARY POLICY Impact of cut in CRR on Interest Rates: From time to time, RBI prescribes a CRR or the minimum amount of cash that banks have to maintain with it. The CRR is fixed as a percentage of total deposit. As more money chases the same number of borrowers, interest rates come down. Impact of change in SLR and Gilt Products on Interest Rates: SLR reduction is not so relevant in the present context for two reasons. First, as part of the reform process, the government has begun borrowing at market-related rates. Therefore, banks get better interest rates compared to what they used to get earlier for their statutory investments in government securities. Second, banks are still the main source of funds for the government. This means that despite lower SLR requirements, banks investment in government securities will go up as government borrowing rises. As a result, bank investment in gilts continues to be high despite the RBI bringing down the minimum SLR to 25% a couple of years ago. Therefore, for the purpose of determining the interest rates, it is not the SLR requirement that is important but the size of the government’s borrowing programme. As government borrowing increases, interest rate, too, rise. Besides, the gilts also provide another tool for the RBI to manage interest rates. The RBI conducts OMO by offering to buy or sell gilts. If it feels that interest rates are too high, it may bring them down by offering to buy securities at a lower yield than what is available in the market Impact of Open Market Operation: The monetary policy of the seventies and first half of the eighties had excluded the open market operations instrument. This is because active Government securities market was non-existent. Active Government securities market could not emerge because of the fact that rates of interest offered on Government paper that is, 90 CU IDOL SELF LEARNING MATERIAL (SLM)

treasury bills and dated Government securities were much below prevailing market rates of interest. Late Prof. S. Chakravarty, the head of Monetary Reforms Committee recommended raising of interest rates on Government securities to ensure profitability of banks and activism of the open market operations. This recommendation was accepted and in the late eighties interest rates of Government securities were raised. In the post reform period, as a first step yields on government securities were made market determined by sale of Government securities through open auction. Furthermore, the interest rate structure was simultaneously rationalized and banks were given the freedom to determine their prime lending rates and other main rates of interest. These measures by RBI facilitated the use of open Market operations as an effective instrument for liquidity management including control of short-term fluctuations in the foreign exchange market. Impact of Bank Rate: Before 1991, changes in bank rate as an instrument of monetary control were quite rare. The bank rate remained unchanged at 10 per cent in the whole decade 1981-91. In the post-reform period Reserve Bank has moved towards a situation in which changes in bank rate give signals to the commercial banks and other financial institutions about the emerging financial situation of the economy so that they could adjust their interest rates accordingly, Besides, bank rate serves as a reference rate on the basis of which commercial banks can fix their- prime lending rates. To control inflationary pressures in the Indian economy Reserve Bank raised bank rate from 10 per cent to 11 per cent in July 1991 and further to 12 per cent in October 1991. Raising of lending rates of interest on the advances to the businessmen was intended to discourage demand for credit. However, it may be noted that the role of bank rate as an instrument of credit control is limited because of the following factors: First, before mid-1990s, because of the administered nature of interest rates the bank rate was not used as a reference rate by the banks for the purpose of fixing their lending rates. Secondly, even now when lending rates of banks have been freed, there is not much refinance being made available at the bank rate so that banks can ignore this as a reference in setting their own lending rates. Thirdly, at present lending rates of interest are determined by demand for and supply of funds in the money market. In fact, the monetary policy regarding bank rate is itself influenced by the prevailing economic situation. Impact of Liquidity Adjustment Facility (LAF): 91 CU IDOL SELF LEARNING MATERIAL (SLM)

Another important change in the instrument of monetary policy is the introduction of Liquidity Adjustment Facility (LAF) from June 2000 to adjust on a daily basis liquidity in the banking system so that it remains within reasonable limits. Besides, through Liquidity Adjustment Facility, the RBI regulates short-term interest rates while its bank rate policy serves as a signaling device for its interest rate policy in the intermediate period. These short-term interest rates of RBI are called repo rate and reverse repo rate. Impact on Domestic Industry and Exporters: The exporters look forward to the monetary policy since the Central Bank always makes an announcement on export refinance, or the rate at which the RBI will lend to banks which have advanced pre-shipment credit to exporters. A lowering of these rates would mean lower borrowing costs for the exporter. Impact on Stock Markets and Money Supply: Most people attribute the link between the amount of money in the economy and movements in stock markets to the amount of liquidity in the system. This is not entirely true. The factor connecting money and stocks is interest rates. People save to get returns on their savings. A hike in interest rates would tend to suck money out of shares into bonds or deposits; a fall would have the opposite effect. This argument has survived econometric tests and practical experience. Impact of Money Supply on Jobs, Wages and Output: At any point of time, the price level in the economy is determined by the amount of money floating around. An increment in the money supply- currency with the public demand deposits, and time deposit – increases prices all around because there is more currency moving towards the same goods and services. Typically, the RBI follows a least inflation policy, which means that its money market operations as well as changes in the bank rate are generally designed to minimize the inflationary impact of money supply changes. Since most people can generally see through this strategy, it limits the impact of the RBI’s monetary moves on jobs or production. The markets, however, move to the RBI’s tune because of the link between interest rates and capital market yields. The RBI’s policies have maximum impact on volatile forex and stock markets. The jobs, wages, and output are affected over the long run, if the trends of high inflation or low liquidity persist for a very long period. If the wages move slower than other prices, higher inflation will drive real wages lower and encourage employers to hire more people. This, in turn, ramps up production and employment. This was the theoretical justification of a long term trend that showed that higher inflation and employment went together, whereas, when inflation fell, unemployment increased. Impact on Money Supply: The RBI uses the interest rate, OMO, changes in the CRR are the most popular instruments used. Under the OMO, the RBI buys or sells government bonds in the secondary market. By absorbing bonds, it drives up bond yields and injects money into the market. When it sells bonds, it does so to suck money out of the system. 92 CU IDOL SELF LEARNING MATERIAL (SLM)

The changes in CRR affect the amount of free cash that banks can use to lend—reducing the amount of money for lending cuts into overall liquidity, driving interest rates up, lowering inflation, and sucking money out of markets. Primary deals in government bonds are a method to intervene directly in markets, followed by the RBI. By directly buying new bonds from the government at lower than market rates, the RBI tries to limit the rise in interest rates that higher government borrowings lead to. 5.6 FISCAL POLICY The term fiscal has been derived from the Greek word fisc, meaning a basket to symbolize the public purse. Fiscal policy thus means the policy related to the treasury of the government. Fiscal policy is a part of general economic policy of the government which is primarily concerned with the budget receipts and expenditures of the government. All welfare projects are completed under this policy. It also suggests measures to control economic fluctuations which may become violent and create great upheavals in the socio-economic structure of the economy. It also outlines the influence of resource utilization on the level of aggregate demand through affecting the level of aggregate consumption and investment expenditure. 5.6.1 Concept and Meaning Fiscal policy means the use of taxation and public expenditure by the government for stabilization or growth. The fiscal policy is concerned with the raising of government revenue and incurring of government expenditure. To generate and to incur expenditure, the government frames a policy called budgetary policy or fiscal policy. So, the fiscal policy is concerned with government expenditure and government revenue. Fiscal Policy has to decide on the size and pattern of flow of expenditure from the government to the economy and from the economy back to the government. So, in broad term, fiscal policy refers to that segment of national economic policy which is primarily concerned with the receipts and expenditure of central government. In other words, fiscal policy refers to the policy of the government with regard to taxation, public expenditure and public borrowings. The importance of fiscal policy is high in underdeveloped countries. The state has to play active and important role. In a democratic society direct method are not approved. So, the government has to depend on indirect methods of regulations. In this way, fiscal policy is a powerful weapon in the hands of government by means of which it can achieve the objectives. Fiscal policy is the term used to describe all of the government’s decisions regarding taxation and spending. When governments want to increase the money available to populace, they lower the taxes and raise spending (expansionary fiscal policy); in contrast, when they want 93 CU IDOL SELF LEARNING MATERIAL (SLM)

to decrease the money available to populace, they raise the taxes and lower spending (contractionary fiscal policy) Government spending and the policies guiding the public expenditure of the government do influence macroeconomic conditions. These policies affect tax rates, interest rates and government spending, in an effort to control the economy. Fiscal policy is the means by which a government adjusts its levels of spending in order to monitor and influence a nation’s economy. Fiscal policy and monetary policy go hand in hand with each other. Both are interdependent on each other. Fiscal policy serves as an important tool to influence the aggregate demand. The instruments of fiscal policy are government spending and taxation. Depending upon existing situation of the economy, government can employ either expansionary or contractionary fiscal policy. Expansionary fiscal policy increases the aggregate demand whereas contractionary or deflationary fiscal policy reduces the aggregate demand. Changes in the level, timing and composition of government spending and taxation have an important effect on the economy. Fiscal policy is the policy of government related to its own expenditure and taxes in order to influence the aggregate demand (AD). It is one of the very important demand –side policies. Demand –side policies focus on changing the AD or shifting the AD curve in the aggregate demand and aggregate supply (AD-AS) model in order to achieve the goals of price stability, full employment, and economic growth. There are four components of AD: consumer spending(C), investment spending (I), government spending (G), and net exports(X-M), where X=exports and M=imports. Fiscal policy influences all of these four components of AD. Government can influence ‘C’ by imposing taxes on consumers, i.e., personal income taxes. It can influence ‘I’ by imposing taxes on business profits. Similarly, government can easily change its own spending. It influences ‘X-M’ by means of subsidies provided to the domestic producers, import tax, and so on. Different economist has given different definitions of Fiscal policy as follows: According to Culbertson, “By fiscal policy we refer to government actions affecting its receipts and expenditures which we ordinarily taken as measured by the government’s receipts, its surplus or deficit.” The government may offset undesirable variations in private consumption and investment by compensatory variations of public expenditures and taxes. Arthur Smithies defines fiscal policy as “a policy under which the government uses its expenditure and revenue programmes to produce desirable effects and avoid undesirable effects on the national income, production and employment.” Though the ultimate aim of fiscal policy in the long-run stabilisation of the economy, yet it can be achieved by moderating short-run economic fluctuations. 94 CU IDOL SELF LEARNING MATERIAL (SLM)

In this context, Otto Eckstein defines fiscal policy as “changes in taxes and expenditures which aim at short-run goals of full employment and price-level stability. According to U. Hicks “Fiscal policy is concerned with the manner in which all the different elements of public finance, while still primarily concerned with carrying out their own duties, may collectively be geared to forward the aims of economic policy.” 5.6.2: Objectives of Fiscal Policy: The fiscal policy is designed to achieve the following objectives: Development by Effective Mobilization 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 Mobilization of Financial Resources. The central and the state governments in India have used fiscal policy to mobilize resources. The financial resources can be mobilized by: Taxation: Through effective fiscal policies, the government aims to mobilize resources by way of direct taxes as well as indirect taxes because most important source of resource mobilization in India is taxation. Public Savings: The resources can be mobilized through public savings by reducing government expenditure and increasing surpluses of public sector Private Savings: Through effective fiscal measures such as tax benefits, the government can raise resources from private sector and households. Resources can be mobilized through government borrowings by ways of treasury bills, issue of government bonds, etc., loans from domestic and foreign parties and by deficit financing. 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 defense, interest payments, subsidies, etc. But generally the fiscal policy should ensure that the resources are allocated for generation of goods and services which are socially desirable. Therefore, India's fiscal policy is designed in such a manner so as to encourage production of desirable goods and discourage those goods which are socially undesirable. 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 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 95 CU IDOL SELF LEARNING MATERIAL (SLM)

implementation of Poverty Alleviation Programmes to improve the conditions poor people in society. Price Stability and Control of Inflation: One of the main objectives 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. 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 generate 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 area. 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. Reducing the Deficit in the Balance of Payment: Fiscal policies attempts to encourage 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 exports. 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 Increasing National Income: 96 CU IDOL SELF LEARNING MATERIAL (SLM)

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. 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. Foreign Exchange 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 problems. 5.6.3 Role of Fiscal Policy: 1. Allocation: The provision for social goods, or the process by which total resource use is divided between private and social goods and by which the mix of social goods is chosen. This provision may be termed as the allocation function of budget policy. Social goods, as distinct from private goods, cannot be provided for through the market system. The basic reasons for the market failure in the provision of social goods are: firstly, because consumption of such products by individuals is non rival, in the sense that one person’s partaking of benefits does not reduce the benefits available to others. The benefits of social goods are externalised. Secondly, the exclusion principle is not feasible in the case of social goods. The application of exclusion is frequently impossible or prohibitively expensive. So, the social goods are to be provided by the government. 2. Distribution: Adjustment of the distribution of income and wealth to assure conformance with what society considers a ‘fair’ or ‘just’ state of distribution. The distribution of income and wealth determined by the market forces and laws of inheritance involve a substantial degree of inequality. Tax transfer policies of the government play an important role in reducing the inequalities in income and wealth in the economy. 3. Stabilization: 97 CU IDOL SELF LEARNING MATERIAL (SLM)

Fiscal policy is needed for stabilization, since full employment and price level stability do not come about automatically in a market economy. Without it the economy tends to be subject to substantial fluctuations, and it may suffer from sustained periods of unemployment or inflation. Unemployment and inflation may exist at the same time. Such a situation is known as stagflation. The overall level of employment and prices in the economy depends upon the level of aggregate demand, relative to the potential or capacity output valued at prevailing prices. Government expenditures add to total demand, while taxes reduce it. This suggests that budgetary effects on demand increase as the level of expenditure increases and as the level of tax revenue decreases. 4. Economic Growth: Moreover, the problem is not only one of maintaining high employment or of curtailing inflation within a given level of capacity output. The effects of fiscal policy upon the rate of growth of potential output must also be allowed for. Fiscal policy may affect the rate of saving and the willingness to invest and may thereby influence the rate of capital formation. Capital formation in turn affects productivity growth, so that fiscal policy is a significant factor in economic growth. 5.7 DIFFERENCE BETWEEN MONETARY AND FISCAL POLICY: 98 CU IDOL SELF LEARNING MATERIAL (SLM)

Table 5.1 Comparison between Monetary and Fiscal policy 5.8 TECHNIQUES OF FISCAL POLICY 5.8.1 Taxation Policy Taxes are the main source of revenue for the government. Government levies both direct and indirect taxes in India. Direct taxes are those which are paid directly by the assessee to the 99 CU IDOL SELF LEARNING MATERIAL (SLM)

government e.g., income tax, wealth tax, etc. Indirect taxes are paid indirectly by the public to the government i.e., the taxes are charged by trader/manufacturer from the public and then paid to government e.g., excise duty, custom duty, value added tax (VAT), service tax, etc. Direct taxes are progressive in nature i.e., the rate of tax increases with the increase in level of income/wealth so people with low income will pay tax at lower rates and people with higher income will pay tax at higher rates. Indirect taxes are not progressive. These are charged from all segments of the society at the same rate, i.e. both rich and poor have to pay indirect taxes at the same rate. In India, in the year 2007-08, direct taxes constituted 49 percent of the total tax collection and indirect taxes constituted 51 percent. Main purposes of the taxation policy in India are as follows: Mobilization of Resources: Tax revenue in India has been rising every year. Government mobilizes resources through taxation for economic development. In the year 2007-08, about 64 percent of revenue of central and state government of India came from tax revenue. Rate of taxes have come down but the collection of tax has increased. To Promote Saving: For this purpose various tax concession, tax deductions are given on savings e.g., Provident Fund, National saving Certificates, Life Insurance Policies, Government Bonds, Mutual Funds, etc. To Promote Investment: Various tax rebates, tax concessions and tax holiday benefits are given to promote the investment in remote and backward or rural areas. Similarly, tax rebates and concessions are given to export-oriented units, so as to encourage investment in these industries. To Bring Equality of Income and Wealth: To achieve this objective different kinds of progressive direct taxes are levied e.g. income tax, wealth tax, etc. i.e., rate of tax is increased with the increase in the income. Similarly, excise duties are levied at higher rate on luxury goods and at lower rates on necessary goods. Tax Structure of Government of India: India has a well-developed tax structure with clearly demarcated authority between Central and State Governments and local bodies. Central Government levies taxes on the following:  Income Tax: Tax on income of a person  Customs duties: Duties on import and export of goods  Central Goods and Service Tax (CGST): Indirect Tax levied on manufacture, sale and consumption of goods and services.  Integrated Goods and Service Tax (IGST): For inter-state transfer of goods and services. State Governments can levy the following taxes: 100 CU IDOL SELF LEARNING MATERIAL (SLM)