Submitted By: Sachin Tandukar MONETARY POLICY Monetary policy is how central banks manage liquidity to create economic growth. Liquidity is how much there is in the money supply. That includes credit, cash, checks and money market mutual funds. The most important of these is credit. It includes loans, bonds and mortgages HOW MONETARY POLICY WORKS The Central Bank may have an inflation target of 2%. If they feel inflation is going to go above the inflation target, due to economic growth being too quick, then will increase interest rates.
Higher interest rates increase borrowing
costs and reduce consumer spending and investment, leading to lower aggregate demand and lower inflation
If the economy went into recession, the
Central Bank would cut interest rates. INSTRUMENTS OF MONETARY POLICY Bank rate policy
Open market operations
Higher CRR & SLR
Selective credit controls(margin
requirements) EXPANSIONARY MONETARY POLICY It is used to overcome recession or depression
When there is fall in consumer & business
demand the government eases the credit market conditions, purchases government securities lowers the reserve requirements which leads to an upward shift in the AD. RESTRICTIVE MONETARY POLICY Restrictive monetary policy is how central banks slow economic growth. Its called restrictive because the banks restrict liquidity. That reduces the amount of money and credit that banks can lend. It lowers the money supply by making loans, credit cards and mortgages more expensive. That constricts demand, which slows economic growth and inflation FISCAL POLICY Fiscal Policy involves the decisions that a government makes regarding collection of revenue, through taxation and about spending that revenue. It is often contrasted with Monetary Policy, in which a central bank(like the federal Reserve in the United States) sets interest rates and determines the level of the money supply. HOW FISCAL POLICY WORKS Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economics, this theory basically states that governments can influence macroeconomics productivity levels by increasing or decreasing tax levels and public spending.
Fiscal policy is very important to the economy. For
example, in 2012 many worried that the fiscal cliff, a simultaneous increase in tax rates and cuts in government spending set to occur in January 2013, would send the U.S. economy back to recession. The U.S. Congress avoided this problem by passing the American Taxpayer Relief Act of 2012 on Jan.1,2013 INSTRUMENTS OF FISCAL POLICY Levels of taxation
Public debts
Levels of government spending
EXPANSIONARY FISCAL POLICY Expansionary Fiscal Policy is designed to stimulate the economy during or anticipation of a business-cycle contraction. This is accomplished by increasing aggregate expenditures and aggregate demand through an increase in government spending or decreases in taxes. Expansionary Fiscal Policy leads to a larger government budget deficit or a smaller budget surplus.
It works through the two sides of the governments
fiscal budget; spending and taxes. However, its often useful to separate these two sides into three specific tools; government purchases, taxes and transfer payments. WHICH IS MORE EFFECTIVE MONETARY OR FISCAL POLICY? In recent decades, monetary policy has become more popular because:
1. Monetary policy is set by the Central bank and
therefore reduces political influence
2. Fiscal policy can have more supply side effects
on the wider economy. E.g. to reduce inflation - higher tax and lower spending would not be popular and the government may be reluctant to purse this. Also lower spending could lead to reduced public services and the higher income tax could create disincentives to work. CONTD However, the recent recession shows that monetary policy too can have many limitations.
1. Targeting inflation is too narrow. This
meant central banks ignored an unsustainable boom in housing market and bank lending.
2. In a liquidity trap, expansionary fiscal
policy will not cause crowding out because the government is making use of surplus saving to inject demand into the economy. THANK YOU