Interaction of Fiscal and Monetary Policy

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Before understanding how the fiscal policy and monetary policy operate in coordination with each other, let us first understand the objective behind the formulation of these policies in brief. Monetary Policy: Monetary policy is the process by which monetary authority of a country, generally a central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth. The central bank in our country is Reserve Bank of India. The main objectives of monetary policy are price stability, controlled expansion of bank credit, promotion of fixed investment, promotion of exports and food procurement operations etc. Fiscal Policy: Fiscal policy refers to the expenditure that government undertakes in order to provide goods and services, and the way in which the government finances those expenditures. Main objectives of fiscal policy of our country are to reduce income inequalities through progressive taxation, to control inflation, to facilitate balanced regional development, employment generation, to allocate resources to social and developmental objectives, to reduce balance of payment deficits etc. At the outset, it must be recognized that both fiscal and monetary policies are essential components of overall macro-economic policy and thus cannot but share the basic objectives such as high economic growth on a sustainable basis implying equity considerations also, a reasonable degree of price stability and a viable balance of payments situation. However, all these objectives may not always be in harmony, and major concerns of each component may be different apart from the differences in time horizon of the concerned policy focus. For achieving an optimal mix of macroeconomic objectives of growth and price stability, it is necessary that the two policies complement each other. However, the form of...
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