This project aims to analyze and critically examine the steps that the Indian Government and Reserve bank can take to stimulate economic growth keeping price level, unemployment level and fiscal deficit in control. In our analysis, we use the IS-LM and the AD-AS supply framework. The IS curve gives the combination of interest rate at which the goods and services market is in equilibrium. The LM curve gives the level of interest rate at which the money and the bonds market is in equilibrium. The intersection of both the curves gives the macroeconomic equilibrium in the economy.
The fiscal and monetary policy undertaken by the government and the Reserve bank shift the IS and the LM curves out of the old equilibrium into the new equilibrium. We attempt to reach the new equilibrium such that the new equilibrium corresponds to our goal of increased income and employment, reduced budget deficit and reduced price level. We are mindful of the fact that there is always a tradeoff between macroeconomic variables. But we attempt to present an optimum policy solution to reach the desired objectives.
The objective of this project is to advice the Government to take fiscal and monetary measure in order to:
Control Price Level
Promote High Level of Employment
Reduce Fiscal Deficit
Promote Healthy Banking Practice Through Monetary Policy
Assumptions in the Analysis
The following assumptions have been made for working out Analysis.
The economy is assumed to be a closed economy i.e. our analysis comprises of the following economic agents: domestic firms, domestic households, the domestic government and financial institutions.
It is in the realm of the shortrun model that we find the greatest role for government policy and hence we consider the impact of our policy measures in the shortrun.
The economy has achieved full employment.
Firms passively produce whatever is demanded .
There is no expected inflation; hence nominal rate of interest is equal to the real rate of interest .
Capital and Technology are given and cannot be changed.
Labour market is imperfectly competitive; there is the influence of trade unions
Output is a function of employment Y = f (n) and employment in turn is a function of real wages n = g (? - p).
Investments are assumed to be an inverse function of rate of interest 'I'. I = I (r) Investments as a function of real assets have been ignored.
There are 2 types of assets: Money and Bonds; the investor has the choice to invest in either of the two.
Consumption expenditure is assumed to be a function of personal disposable income and consumption as a function of real assets has been ignored.
Savings is assumed to be a function of personable disposable income and not of real assets.The present level IS & LM curves are 'IS' & 'LM'. Correspondingly, the aggregate demand and aggregate supply curves are 'AD' and 'AS'. The current general price level is P 0 .
According to Arther Simithies fiscal policy is a policy under which government uses its expenditure and revenue programme to produce desirable effects and avoid undesirable effects on the national income, production and employment. Fiscal policy is used by governments to influence the level of aggregate demand in the economy, in an effort to achieve economic objectives of price stability, full employment and economic growth. Keynesian economics suggests that adjusting government spending and tax rates, are the best ways to stimulate aggregate demand. This can be used in times of low economic activity as an essential tool in providing the framework for strong economic growth and working toward full employment.
Government can make use of various instruments of fiscal policy:-
Changes in the above instruments can have an impact on the following variables in the economy:
Aggregate demand and the level of economic activity
The pattern of resource allocation
The distribution of income
Monetary Policy regulates the supply of money and the cost and availability of credit in the economy. It is the process by which the government, central bank, or monetary authority manages the nominal supply of money. Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, investments, price level, and unemployment.