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ByBaak KOHAN

Berika TATEKN

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The government plays a major role in themacroeconomy, so a useful way of learning how themacroeconomy works is to consider how thegovernment uses policy to affect the economy.

The two main policies are;

1. Monetary Policy

2. Fiscal Policy

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Monetary policy is an instrument whicheffect the credit flow in an economy.

The variation effect the demand & supply of

credit in an economy, and the level or natureof economic activities.

The term monetary policy refers to actions

taken by central banks to affect monetarymagnitudes or other financial conditions.

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It is concerned with the changing the

supply of money stock and rate ofinterest for the purpose of stabilizingthe economy at full employment or

potential output level by influencingthe level of aggregate demand.

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Monetary policy controls the valueof currency by lowering the supply

of money to control inflation andraising it to stimulate economicgrowth. It is concerned with the

amount of money in circulationand, consequently, interest rates

and inflation.

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Monetary policyin the United States is controlled by theFederal Reserve, the nations central bank. The Fed, as it isusually called, determines the quantity of money in theeconomy, which in turn affects interest rates.

The Feds decisions have important effects on the economy.Infact, the task of trying to smooth out business cycles inthe United States is generally left to the Fed (that is, tomonetary policy). The chair of the Federal Reserve issometimes said to be the second most powerful person inthe United States after the president.

The Fed played a more active role in the 2008-2009recession than it had in previous recessions. Fiscal policy, however, also played a very active role in the

2008-2009 recession.

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Interest rates can be raised as high as monetaryauthorities wish

Open market operations curtail liquidity of bank and

non-bank groups Margin requirements and consumer credit controls

can also be tightened.

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Stability in price level Economic development

Arrangement of full employment

Expansion of credit facility

Equality & Justice Stability in exchange rate To offset decline in velocity of money

To satisfy demand for precautionary & speculative motive

To strengthen the cash position of banks & non-bank groups Stimulate lending for investment & consumption purpose

Bring down structure of interest rates to encourage investment.

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Monetary policy and savings.

Monetary policy and investment.

Cost of credit..

i) Monetary policy and public investment.ii) Monetary policy and private investment.

iii)Allocation of investment funds.

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GENERAL (QUANTITATIVE) Methods

SELECTIVE (QUALITATIVE) Methods

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Meaning:-

These methods help in credit control in the economy.

Affect total quantity of the credit.

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Bank rate policy

Open market policy

Cash reserve ratio

Statuary reserve ratio

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Adopt for expansion and contraction of credit to attainspecific objective.

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Credit rationing

Change in margin

Direct action

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At times of recession monetary policy involves theadoption of some monetary tools which tends toincrease the money supply and lower interest rate so asto stimulate aggregate demand in the economy.

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At the time of inflation monetary policy seeks tocontract aggregate spending by tightening the moneysupply or raising the rate of return.

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Bank rate policy

Open market operations

Changing cash reserve ratio

Undertaking selective credit controls.

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Bank rate is the minimum rate at which the centralbank of a country provides loan to the commercial

bank of the country. Open market operation means the purchase and sale of

securities by central bank of the country.

Reverse Repo rate is the rate at which banks park

their short-term excess liquidity with the RBI.

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The distinction between the various types of monetarypolicy lies primarily with the set of instruments andtarget variables that are used by the monetaryauthority to achieve their goals.

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Measures related to taxation & public expenditure arenormally called fiscal measures and the policyconcerning them as known as FISCAL POLICY.

In short, fiscal policy or budgetary policy consists ofsteps & measures which the government in order tofulfill the aims of economic policy.

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To achieve and maintain the full employment in theeconomy.

Attain Economic growth in long term.

Achieve economic stability.To guide the allocation of existing resources into

socially necessary lines of development

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We define Fiscal Policy to include any design to changeprice level, composition or timing of governmentexpenditure or to vary the burden, structure orfrequency of the tax payment.

G.K. Shaw

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Fiscal policy was discovered by Keynes in 1930s =>most powerful instrument for affecting the volumeof aggregate effective demandor desiredexpenditure and thus the level ofnational

income, employment andprice level.

Applied his fiscal policy prescription in the contextof the great depression of 1930s.

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Taxes

Expenditure

Public debtBudget

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Fiscal policy, especially tax policy, can be used to enhancegrowth, by encouraging the efficient use of any givenamount of scarce resources.

The primary function of a tax system is to raise revenue for

the government for its public expenditure. So the first goalin the development strategy as regards taxation policy is toprovide that this function is discharged enough.

To reduce inequalities through a policy of redistribution ofincome and wealth. Higher rates of income taxes, capital

transfer taxes and wealth taxes are some means adopted forachieving these ends.

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For social proposes such as discouraging certain activities which are considered

undesirable. The excise taxes on liquor and tobacco, the special excise duties on luxury

goods, betting and Gaming Levy are examples of such taxes, which apart from being

lucrative revenue sources have also goals.

To ensure economic goals through the ability of the taxation system to influence the

allocation of resources. This includes :

a) transferring resources from the private sector to the government to finance thepublic investment program;

b) the direction of private investment into desired channels through such measures as

regulation of tax rates and the grant of tax incentives etc. This includes investment

incentives to attract foreign direct investment (FDI) into the country;

c) Influencing relative factor prices for enhanced use of labour and economising theuse of capital and foreign exchange.

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Refers to public borrowing and repayment.

If the deficits continue for long periods, the

accumulation ofPUBLIC DEBT and rising interestpayments on that debt will raise interest ratesfurther over time, depressing aggregate demandand jeopardizing the government's ability to

undertake further revenue and expenditurechanges for stabilization purposes.

http://www.thecanadianencyclopedia.com/articles/public-debthttp://www.thecanadianencyclopedia.com/articles/public-debthttp://www.thecanadianencyclopedia.com/articles/public-debthttp://www.thecanadianencyclopedia.com/articles/public-debt

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Public expenditure embraces all the public sectorspending including that of central governments,state governments, local authorities and publiccorporations.

The pattern of public expenditure is influenced byinterest groups and by economic, political,demographic, sociological and technologicalfactors.

In addition, international demonstration effectinduces developing countries like India to followspending patterns of advanced countries.

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During Inflation: Aims at controlling excessiveaggregate spending.

During Depression: Aims at making up deficiency ineffective demand; and avoiding unemployment.

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Contra Cyclical Budgetary Policy

Manipulation and managing the budget to removeperiodic fluctuations.

Unbalanced BudgetDuring depression implies deficit spending byincreasing government outlays (expansionary), whileduring inflation implies surplus budget by curtailing

government expenditures (deflationary)

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Built-in Stabilizers:both taxes and transfer payments may vary withchanges in income levels.

Stabilizer counteracts fluctuations in economics

activities Built-in come into play automatically when income

level changes

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Effectiveness depends upon the size and timing of themeasure adopted.

Political and administrative delays

Success depends upon redistribution of income and achain of economic and psychological reactions of thepeople.

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