Econ 56 Monetary and Fiscal Policy

8/9/2019 Econ 56 Monetary and Fiscal Policy

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refers to the actionsthat governments take in the economicfield;

It covers the systems for setting levels of:

la b or m a r k e t , n a t ion a l own e r s h ip , a n d m a n y o t h e r a r e a s o f g ov e r n m e n t in t e r v e n t ion s in t o t h e e conom y .

In t e r e s t r a t e s a s we ll a s t h e

Mon e y s u p p ly

Gov e r n m e nt u d g e t s

! a " a t ion

!he ideal economic policy, both fortoday and tomorrow, is very simple:

Government should protect and defendagainst domestic and foreign aggressionthe lives and property of the personsunder its #urisdiction, settle disputesthat arise, and leave the peopleotherwise free to pursue their variousgoals and ends in life.

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Measured by the annual change in ourreal G '.

Increased living standards( Improved unemployment ( $pportunity for increased investment.


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Ma"imi)ing economiescapacity to produce,leading to increased livingstandards(

Minimi)ing economic andsocial problems.


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To keep inflation at an acceptable level.Inflation is a problem because:

Reduces international competitiveness;Depreciation of exchange rates;

Distort economic decision making;Distort resource allocation.


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External stability

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*chieving e+uilibrium in the currentaccount of the balance of payments(Maintaining international con dence(

Maintaining acceptable level offoreign debt.


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-conomic activity may create sidee/ects for the environment, suchas depletion of resources('ollution and any other damage tothe environment. -nvironmentalmanagement may lose out, if thereis to be stronger growth.

Most factors of economic policy can bedivided into two:

M$0-!*12 '$3I42 5 which deals withcentral banking actions regarding themoney supply and interest rates.%I64*3 '$3I42 which deals withgovernment actions regarding ta"ationand spending.


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Monetary 'olicy !he process whereby the monetary authorityattempts to achieve a desired set of economicgoals by controlling either the money supply, thecost and availability of credit or the allocation ofcredit to its various uses.

'rofessor 7ames oughton of Indiana 8niversity

It involves ad#usting the level of money supply ina way that it slows down or speeds up an

economy.'rofessor Mira omediano 9%inance ;


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6ummary of Monetary 'olicy-*62 M$0-!*12

'$3I42 Problem :

unemployment andde


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!he Bangko Sen ral ng Pili!inas isresponsible for implementing the monetarypolicies formulated by the members of the

Monetary oard.

!he Governor is the chief e"ecutive o>cer of6' and is re+uired to direct and supervise theoperations and internal administration of 6'. "o#ernor Amando M$ Te angco %r ., current 6'

governor

!he primary ob#ective of the 6'?smonetary policy:@to promote price stability conducive to abalanced and sustainable growth of theeconomyA

91epublic *ct BCDE;.

!he primary monetary goals of the angko6entral ng 'ilipinas are:

F. !o maintain internal and e"ternalmonetary stability in the 'hilippines and topreserve the international value of thepeso and its convertibility into other freelyconvertible currencies( and

. !o foster monetary, credit and e"changeconditions favorable to a balanced andsustainable growth of the economy.


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3egal reservere+uirements

$pen market operations9$M$s;

Moral suasion


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3egal reserve re+uirements

increase or decrease of the percentage of

reserve deposits of banks as re+uired by the4entral ank.

$pen market operations 9$M$s; !he buy and sell of short term government

securities to in


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!he distinction between the various types of monetary policy liesprimarily with the set of instruments and targets variables that areused by the monetary authority to achieve their goals.


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6hortcomings of monetarypolicy

Policy&ins iga ed c'anges in moneys(!!ly may be partially o/set by changesin the velocity of money(

Cos in)a ion : higher interest rates impacton costs of production(

Poli ical sensi i#i y : higher interest rateshave a signi cant impact on housing loansand overdrafts for small business(


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6hortcomings of monetarypolicy

Time Lags* If the gov t plans to increasespending this can take along time to lter intothe economy and it may be too late. 6pendingplans are only set once a year. !here is also a

delay in implementing any changes to spendingpatterns. Leng 'y !rocess* Hhen a monetary or

nancial problem emerges, monetary authorities

have to con rm it by gathering, presenting andanalysing facts to create appropriate monetarypolicies. !he whole process takes time.


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eynes advocated the use of scal policyas a way to stimulate economies duringthe great depression(

%iscal 'olicy was particularly used in theDJs and CJs to stabilise economic cycles.

!hese policies were broadly referred to as

K eynesian ( In the FLBJs and Js governments tended

to prefer monetary policy for in


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'rovision of 6ocial goods

SOCIAL "OO+** good or service that bene ts the largestnumber of people in the largest possible

way. 6ome classic e"amples of social goodsare clean air , clean ,a er and li eracy (in addition, many economic proponentsinclude access to services such ashealthcare in their de nition of the socialor Ncommon goodN.


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!raits of social goods:-$ Non&e.cl(dabili y

there must be no way to e"clude anyone

from consuming it.

/$ Non&ri#alry one person s consumption of the good

must not diminish another person s abilityto consume the good.


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'roblem of social goods provision:Free&rider !roblem$6I!8*!I$0: 6uppose the government decided thatanyone who wanted to bene t from nationaldefence would therefore have to pay for it. Hhatwould be the incentive to payO !he problem is thatpeople would recogni)e that there is no way the

government could prevent them from bene tingfrom the national defence if they did not pay for it.*s a result, many people would consume theservice 9take advantage of national defence;without paying for it.


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%iscal e/ects on theeconomy

8nemployment

-"pansion

4ontraction

In


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Governments also work toencourage economic growthas a whole, funding e"pansionthrough subsidies, ta" cuts

and new contracts withdomestic and internationalpartners. In many cases, thiscan actually encourage

in


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4ontractionGovernments worried about in


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In


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+isincen i#es o0 Ta. C( s$ Increasing !a"es to reduce * may cause

disincentives to work, if this occurs there will be afall in productivity and *6 could fall. =oweverhigher ta"es do not necessarily reduce incentivesto work if the income e/ect dominates.

Side E1ec s on P(blic S!ending . 1educed gov t spending to Increase * could

adversely e/ect public services such as publictransport and education causing market failure andsocial ine>ciency.

Poor In0orma ion . %iscal policy will su/er if the gov t has poor

information. 9e.g. If the gov t believes there isgoing to be a recession, they will increase * ,however if this forecast was wrong and theeconomy grew too fast, the gov t action wouldcause in


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4oordination betweenmonetary & scal policy

%iscal policy and monetary policy are the twotools used by the 6tate to achieve itsmacroeconomic ob#ectives.

!he 2scal !olicies have a direct impact onthe goods marke and the mone ary!olicies have an direct impact on the assemarke s ( since the two markets areconnected to each other via the two macrovariables output and interest rates, thepolicies interact while in


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4oordination betweenmonetary & scal policy


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Econ 56 Monetary and Fiscal Policy