(25) WRITE THE FOLLOWING AS AN ESSAY OF AT LEAST 800 WORDS AND INCLUDE MACROECON
ID: 1194925 • Letter: #
Question
(25) WRITE THE FOLLOWING AS AN ESSAY OF AT LEAST 800 WORDS AND INCLUDE MACROECONOMIC GRAPHS WHERE APPROPRIATE. Monetary Policy has many advantages over Fiscal Policy. However, there are situations in which Monetary Policy is ineffective to help the economy. Discuss in some detail the advantages Monetary Policy has over Fiscal Policy. Explain what circumstances might render Monetary Policy ineffective. Additionally, discuss what products offered and what changes made in Financial Markets have increased the relative liquidity of some normally illiquid assets, and how they make it more difficult for the FED to track the M1 money supply and administer monetary policy.
Explanation / Answer
Situations in which Monetary Policy is ineffective:
Main reasons for the instruments of monetary policy to be ineffective are the following:
1.Higher Proportion of Non-Banking Credit: A substantial proportion of credit extended is by the non-banking institutions (NBIs). This segment is not affected by the changes in the bank rate and ratios. The linkages between the banks and the NBIs are not well developed. Further, the banks have largely tapped non- deposit resources by way of call money market and participation certificates. The call money rates are generally beyond the purview of the RBI.
2.Limitations of Monetary Instruments:The frequent changes in the rates of monetary policy instruments are ineffective on the ground that they create an environment of uncertainty for productive investment.
3.Influence of New Financial Institutions: Institutions like mutual funds, venture capital companies and the public offers floated in the open market (to raise capital) have an abundant influence in effecting the overall liquidity in the economy. Mutual funds, account for nearly 25 per cent of the total household savings in the economy. Thus, the new financial institutions together account for a significant proportion of overall liquidity besides leading to a high degree of disintermediation. The effect of RBI’s interventions is insignificant in these segments of the financial system.
Advantages Monetary Policy has over Fiscal Policy:
1.A major advantage of monetary policy over fiscal policy is that monetary policy can be put into effect more quickly.
2.Fiscal policy inevitably involves borrowing money. Whether the money is wisely spent is another matter, but as the country continues to borrow, the debt continues to grow. Monetary policy does not add to the debt. When the Fed wishes to raise interest rates and slow the economy it can do so without impacting the debt. Likewise when it wishes to stimulate the economy its actions have no impact on the debt.
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