Financial stability is generally the domain of monetary authority; however, the fiscal policy of the government has the potential to either facilitate or undermine it. Analyze in the context of India.

Financial stability in a broader sense means keeping the macro economic fundamentals stable i.e, Inflation, interest rates, liquidity, etc. Monetary policy refers to tools used by the RBI to maintain financial stability in the economy, for example – CRR, SLR, Repo rates, etc.

Fiscal stability: Domain of monetary policy –

  • Tools used by RBI to infuse or soak up liquidity from the economy to stabilize inflation like open market tools (sale/purchase of government securities)
  • RBI helps maintain daily mismatches in demand & supply of credit with the banks e.g, Liquidity adjustment facility, marginal standing facility
  • Monetary policy helps stabilize bond yields and prices.
  • Monetary policy tools used by RBI hold increase demand/savings by households/investors etc. by making necessary fluctuations in Repo/Reverse Repo Rates.
  • RBI also checks that adequate monetary transmission happens in the economy to keep microeconomic fundamentals in check.

How does fiscal policy facilitate:

  • Monetary and fiscal policy of an economy work hand in hand to complement each other. In general, fiscal policy is counter-cyclical in India to stabilize the effects of economic cycles of boom and bust.
  • Progressive taxation, fixing inflation targets along with RBI (Monetary Policy Committee), fixing various tax rates, etc. facilitates fiscal stability across sections of the economy.

How can fiscal policy undermine:

  • Populist policies of the government can undermine the efforts of monetary policy in maintaining macro-economic fundamentals e.g, farm loan waiver, ever-increasing fiscal deficit, etc.
  • Fiscal policy can also, at times intrude on the independence of RBI to undermine the effects of monetary policy tools.
  • Unrealistic measures like insurance subsidies, unworthy lending, and unsecured borrowing can also undermine fiscal stability.

In India therefore, close coordination of fiscal and monetary policy remains inevitable while simultaneously maintaining relative independence of RBI as well as public welfare aims of the government.

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