By Baak KOHAN Berika TATEKN

The government plays a major role in the

macroeconomy, so a useful way of learning how the macroeconomy works is to consider how the government uses policy to affect the economy. The two main policies are; 1. Monetary Policy 2. Fiscal Policy

 Monetary policy is an instrument which

effect the credit flow in an economy. The variation effect the demand & supply of credit in an economy, and the level or nature of economic activities. The term monetary policy refers to actions taken by central banks to affect monetary magnitudes or other financial conditions.

 It is concerned with the changing the

supply of money stock and rate of interest for the purpose of stabilizing the economy at full employment or potential output level by influencing the level of aggregate demand.

 Monetary policy controls the value

of currency by lowering the supply of money to control inflation and raising it to stimulate economic growth. It is concerned with the amount of money in circulation and, consequently, interest rates and inflation.

 Monetary policy in the United States is controlled by the

Federal Reserve, the nations central bank. The Fed, as it is usually called, determines the quantity of money in the economy, 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 in the United States is generally left to the Fed (that is, to monetary policy). The chair of the Federal Reserve is sometimes said to be the second most powerful person in the United States after the president. The Fed played a more active role in the 2008-2009 recession than it had in previous recessions. Fiscal policy, however, also played a very active role in the 2008-2009 recession.

 Interest rates can be raised as high as monetary

authorities wish Open market operations curtail liquidity of bank and non-bank groups Margin requirements and consumer credit controls can also be tightened.

 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.

 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.

 GENERAL (QUANTITATIVE) Methods SELECTIVE (QUALITATIVE) Methods

 Meaning: These methods help in credit control in the economy.

Affect total quantity of the credit.

 Bank rate policy Open market policy

Cash reserve ratio

Statuary reserve ratio

 Adopt for expansion and contraction of credit to attain

specific objective.

 Credit rationing Change in margin

Direct action

 At times of recession monetary policy involves the

adoption of some monetary tools which tends to increase the money supply and lower interest rate so as to stimulate aggregate demand in the economy.

 At the time of inflation monetary policy seeks to

contract aggregate spending by tightening the money supply or raising the rate of return.

 Bank rate policy

Open market operations

Changing cash reserve ratio Undertaking selective credit controls.

 Bank rate is the minimum rate at which the central

bank 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.

 The distinction between the various types of monetary

policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals.

 Measures related to taxation & public expenditure are

normally called fiscal measures and the policy concerning them as known as FISCAL POLICY.
In short, fiscal policy or budgetary policy consists of

steps & measures which the government in order to fulfill the aims of economic policy.

 To achieve and maintain the full employment in the

economy. Attain Economic growth in long term. Achieve economic stability. To guide the allocation of existing resources into socially necessary lines of development

We define Fiscal Policy to include any design to change price level, composition or timing of government expenditure or to vary the burden, structure or frequency of the tax payment.
G.K. Shaw

 Fiscal policy was discovered by Keynes in 1930s =>

most powerful instrument for affecting the volume of aggregate effective demand or desired expenditure and thus the level of national income, employment and price level.
Applied his fiscal policy prescription in the context

of the great depression of 1930s.

Taxes Expenditure Public debt

Budget

Fiscal policy, especially tax policy, can be used to enhance growth, by encouraging the efficient use of any given amount of scarce resources. The primary function of a tax system is to raise revenue for the government for its public expenditure. So the first goal in the development strategy as regards taxation policy is to provide that this function is discharged enough. To reduce inequalities through a policy of redistribution of income and wealth. Higher rates of income taxes, capital transfer taxes and wealth taxes are some means adopted for achieving these ends.

 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 the public 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 the use of capital and foreign exchange.

 Refers to public borrowing and repayment. If the deficits continue for long periods, the

accumulation of PUBLIC DEBT and rising interest payments on that debt will raise interest rates further over time, depressing aggregate demand and jeopardizing the government's ability to undertake further revenue and expenditure changes for stabilization purposes.

 Public expenditure embraces all the public sector

spending including that of central governments, state governments, local authorities and public corporations. The pattern of public expenditure is influenced by interest groups and by economic, political, demographic, sociological and technological factors. In addition, international demonstration effect induces developing countries like India to follow spending patterns of advanced countries.

During Inflation: Aims aggregate spending.

at

controlling

excessive

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

Contra Cyclical Budgetary Policy Manipulation and managing the budget to remove periodic fluctuations. Unbalanced Budget During depression implies deficit spending by increasing government outlays (expansionary), while during inflation implies surplus budget by curtailing government expenditures (deflationary)

 Built-in Stabilizers:

both taxes and transfer payments may vary with changes in income levels. Stabilizer counteracts fluctuations in economics activities Built-in come into play automatically when income level changes

 Effectiveness depends upon the size and timing of the

measure adopted. Political and administrative delays Success depends upon redistribution of income and a chain of economic and psychological reactions of the people.