Fiscal deficit monetary policy framework from "summary" of Indian Economy: Performance and Policies by Uma Kapila
Fiscal deficit is the excess of total expenditure over total receipts excluding borrowings during a particular period. It reflects the borrowing requirements of the government to meet its expenditure. The fiscal deficit has a direct impact on the money supply in the economy. When the government resorts to borrowing to finance its spending, it injects money into the system. This excess liquidity can lead to inflationary pressures in the economy. Monetary policy, on the other hand, refers to the measures taken by the central bank to control the supply of money in the economy. One of the key objectives of monetary policy is to maintain price stability. In the context of fiscal deficit, monetary policy plays a crucial role in managing the liquidity in the economy. The central bank can use various tools such as open market operations, reserve requirements, and policy interest rates to control the money supply. The fiscal deficit monetary policy framework refers to the coordination between fiscal and monetary authorities to achieve macroeconomic objectives. In this framework, the government's fiscal policy stance should be consistent with the monetary policy stance of the central bank. If the government runs a high fiscal deficit, it can put pressure on the central bank to tighten monetary policy to control inflation. On the other hand, if the government follows a prudent fiscal policy, it can provide room for the central bank to adopt an accommodative monetary policy stance to support growth. The effectiveness of the fiscal deficit monetary policy framework depends on the credibility and coordination between fiscal and monetary authorities. If there is a lack of coordination between the two authorities, it can lead to conflicting policy actions and undermine the effectiveness of macroeconomic management. Therefore, it is essential for the government and the central bank to work together to ensure that fiscal and monetary policies are aligned to achieve the desired macroeconomic outcomes.
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