Economics

(a) Objectives of Fiscal Policy — 3 marks

Fiscal policy is the government's use of taxation, public expenditure and public borrowing to influence the economy. Its main objectives are:

1. Economic growth — directing public investment into infrastructure, energy, education and health to raise productive capacity.
2. Price stability — adjusting taxes and spending to control inflationary or deflationary pressure.
3. Full employment — increasing government expenditure and cutting taxes to create demand and jobs.
4. Equitable distribution of income and wealth — progressive taxation and targeted welfare spending to reduce inequality.
5. Balanced regional development — channelling investment to backward regions.
6. Economic stability / balance of payments — managing aggregate demand and external sector balance.
7. Mobilisation of resources — raising domestic revenue to finance development without excessive dependence on foreign aid.

(b) Interrelationship between Monetary Policy and Fiscal Policy — 7 marks

Meaning. Monetary policy is the central bank's management of money supply, credit and interest rates (in Nepal, through Nepal Rastra Bank). Fiscal policy is the government's management of revenue and expenditure (through the Ministry of Finance and the annual budget). Both are demand-management tools and must work together for macroeconomic stability and growth.

1. Complementary in achieving common objectives. Both target growth, price stability, employment and external balance. Neither alone can achieve them: fiscal policy creates demand and infrastructure; monetary policy provides the liquidity and credit to finance it. For example, expansionary fiscal policy (higher capital spending) needs accommodative monetary policy (adequate credit at reasonable interest) to be effective.

2. Financing of fiscal deficit. A fiscal deficit must be financed either by borrowing from the public/banks or by borrowing from the central bank. If the government borrows heavily from the central bank (deficit financing), money supply expands and inflation rises — monetary policy is then forced to tighten. In Nepal, NRB's overdraft to the government and its purchase of government securities directly link the two.

3. Crowding-out effect. Large government borrowing from the domestic market raises demand for loanable funds, pushes up interest rates and "crowds out" private investment. Monetary policy can offset this by expanding credit or lowering the bank rate, but only partially. Thus fiscal expansion without monetary accommodation reduces private investment.

4. Interest rate and debt management. The cost of government debt depends on interest rates set under monetary policy. Low interest rates reduce debt-servicing burden and encourage borrowing; high rates do the opposite. Conversely, the size of government debt and its maturity structure influence the money market and the effectiveness of open market operations.

5. Inflation control requires both. Inflation may arise from excess demand created by fiscal expansion or from excess money supply created by monetary expansion. Controlling it requires fiscal contraction (cut in spending, higher taxes) together with monetary tightening (higher bank rate, credit ceiling, open market sale of securities). One-sided action usually fails or causes recession.

6. Exchange rate and balance of payments. Fiscal policy affects aggregate demand and imports; monetary policy affects capital flows and reserves. To defend the exchange rate and reserves, a tight monetary policy must be supported by fiscal discipline, otherwise the external imbalance persists. Nepal's pegged exchange rate with the Indian rupee makes this coordination especially important.

7. Coordination in developing economies. In a developing country like Nepal, monetary policy alone cannot induce structural change; fiscal policy must build capital formation. At the same time, fiscal policy needs monetary support to keep inflation and interest rates stable. Hence the annual budget and NRB's monetary policy statement are prepared in consultation, and the government and NRB coordinate through the Nepal Rastra Bank Board and the Ministry of Finance.

8. Limits and conflicts. The two can conflict: fiscal policy is politically driven and rigid, while monetary policy is technically managed and flexible. Excessive fiscal expansion may force monetary tightening, slowing growth. Therefore the two must be harmonised — fiscal policy providing the development thrust and monetary policy providing stability — for sustainable economic growth.

Conclusion. Monetary and fiscal policies are not substitutes but complements. Their proper coordination is essential for price stability, growth, employment and external balance in Nepal.