MONETARY POLICY

&

Fiscal Policy

OF
It covers the systems
setting
levels of:
refers for
tofor
the
actions
It covers the systems
setting
levels of:

The ideal
ideal economic
economic
policy,
both for
for
Mon
that governments
take
ineboth
the
The
policy,
y economic
suppsimple:
ly
today
and
tomorrow,
is
very
field;
today and tomorrow, is very simple:

Interest ratesa

Government
should
protect
andsdefend
defend
Government should protect
well aand
s the
against
domestic
and
foreign
aggression
Measured
by
the
annual
change
in our
against
domestic
and
foreign
aggression
T
a
a
b
ti
x
la
onthe annual ochange
Measured by
r market, nin
our
a
ti
opersons
n al
o
wnershipof
the
lives
and
property
the
real
GDP.
,
a
nd manpersons
y other
the real
lives
of
the
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a
re
a
s
o
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g
o
vernmdisputes
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vernm
ent
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te
r
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e
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o
Increased
n
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s into the
t Budg
ets
e
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my.
that
Improved
arise,
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leave
people
unemployment
;
that
Improved
arise,unemployment
and leave; the people
otherwise
free
to
pursue
their
various
Opportunity
for
increased
investment.
otherwise
free
to
pursue
their
various
Opportunity
for increased investment.
goalsand
andends
endsininlife.
life.
goals

OF

Maximizing economies
capacity to produce,
leading to increased living
standards;
Minimizing economic and
social problems.

OF

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.

OF

External stability
Achieving equilibrium in the current
account of the balance of payments;
Maintaining international confidence;
Maintaining acceptable level of
foreign debt.

OF
Distribution of income and wealth
Create a fairer distribution of
income and wealth in an economy.

OF

Most factors of economic policy can be

divided into two:
MONETARY
POLICY
which
deals with
Economic
activity
may create
sidecentral
actions such
regarding the
effects
forbanking
the environment,
money
supply
and interest rates.
as
depletion
of resources;
Pollution
any other
to
FISCAL and
POLICY
- damage
which deals
with
the
environment.
Environmental
government
actions
regarding taxation
management
may lose out, if there
and spending.
is to be stronger growth.

Monetary Policy
The process whereby the monetary authority
attempts to achieve a desired set of economic
goals by controlling either the money supply, the
cost and availability of credit or the allocation of
credit to its various uses.
Professor James Boughton of Indiana University

It involves adjusting the level of money supply in

a way that it slows down or speeds up an
economy.
Professor Mira Bomediano (Finance 22)

Summary of Monetary Policy

EASY MONETARY
POLICY
Problem:
unemployment and
deflation
Remedy: induce an
expansion in the
supply of money,
and therefore
spending, by
reducing the
interest rate
Means: Buy bonds
in the open market

TIGHT MONETARY
POLICY
Problem: inflation
Remedy: induce a
contraction in the
supply of money,
and therefore
spending, by
increasing the
interest rate
Means: Sell bonds
in the open market

The
monetary
goalsngof Pilipinas
the Bangko
Theprimary
Bangko
Sentral
is
ng Pilipinas
are:
Sentral
responsible
for implementing
The primary
objective
ofthethemonetary
BSP's
formulated
by the members
of the
1. policies
To
maintain
and external
monetary
policy:internal
Monetary
Board.
monetary
stability
the Philippines
and
to promote
price in
stability
conducive
toto
a
preserve the international value of the
balanced and sustainable growth of the
The
is the chief executive
officer
of
pesoGovernor
and its convertibility
into other
freely
economy
BSP
and is required
to direct
convertible
currencies;
and and supervise the
(Republicand
Actinternal
7653). administration of BSP.
operations
2. To foster monetary, credit and exchange
Governor Amando M. Tetangco Jr., current BSP
conditions
favorable to a balanced and
governor
sustainable growth of the economy.

Legal reserve
requirements
Open-market operations
(OMOs)

Moral suasion

Legal reserve requirements

increase or decrease of the percentage of
reserve deposits of banks as required by the
Central Bank.

Open-market operations (OMOs)

The buy and sell of short-term government
securities to influence the level of short time
interest rates to control amount of money in
the financial system.

Moral suasion
appeal of the Central Bank to the banks to
expand or contract their credit or to suspend
types of bank credit.

The distinction between the various types of monetary policy lies

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

Shortcomings of monetary
policy
Policy-instigated changes in money
supply may be partially offset by changes
in the velocity of money;
Cost inflation: higher interest rates impact
on costs of production;
Political sensitivity: higher interest rates
have a significant impact on housing loans
and overdrafts for small business;

Shortcomings of monetary
policy

Time Lags: If the govt plans to increase

spending this can take along time to filter into
the economy and it may be too late. Spending
plans are only set once a year. There is also a
delay in implementing any changes to spending
patterns.
Lengthy process: When a monetary or
financial problem emerges, monetary authorities
have to confirm it by gathering, presenting and
analysing facts to create appropriate monetary
policies. The whole process takes time.

THE
BRIEF
PURPOSE
HISTORY
Keynes
Stimulate
economic
in a policy
advocated
the growth
use of fiscal
period
of a
as
a way
torecession;
stimulate economies during
great
depression;
the
Keep
inflation
low;
Fiscal
Policyfiscal
was policy
particularly
Basically,
aimsused
to in the
50s
and 60s
to stabilise
economic
cycles.
stabilise
economic
growth,
together
These policies were broadly referred to as
with monetary policies, avoiding a
Keynesian;
boom
and
bust
economic
cycle.

In the 1970s and 80s governments tended

to prefer monetary policy for influencing
the economy. Fiscal policy became more
prominent during the great depression of

Provision of Social goods

SOCIAL GOOD:
A good or service that benefits the largest
number of people in the largest possible
way. Some classic examples of social goods
are clean
air, clean water and literacy;
in addition, many
economic proponents
include access to services such as
healthcare in their definition of the social
or "common good".

Provision of Social goods

Traits of social goods:
1. Non-excludability

there must be no way to exclude anyone

from consuming it.

2. Non-rivalry

one persons consumption of the good

must not diminish another persons ability
to consume the good.

Provision of Social goods

Problem of social goods provision:
Free-rider problem.
SITUATION: Suppose the government decided that
anyone who wanted to benefit from national
defence would therefore have to pay for it. What
would be the incentive to pay? The problem is that
people would recognize that there is no way the
government could prevent them from benefiting
from the national defence if they did not pay for it.
As a result, many people would consume the
service (take advantage of national defence)
without paying for it.

Fiscal effects on the

economy
Unemployment
Expansion
Contraction
Inflation Issues

Unemploymen
t
is often stable

in the
long term, with a certain
amount of the population
unable to work simply
because of the constraints
of a free market economy.
Governments
often
choose to develop fiscal
policies that attempt to
decrease this stable rate
of
unemployment.

Governments also work to

encourage economic growth
as a whole, funding expansion
through subsidies, tax cuts
and
new
contracts
with
domestic and international
partners. In many cases, this
can
actually
encourage
inflation if a government only
works
to
help
increase
demand and buying power
within its economy. Demand
goes up, prices rise and then

Contraction
Governments worried about inflation can
attempt to decrease inflation rates through
contraction, using fiscal policy to reign in
natural inflation. The government usually
switches interest rates, raising them to
discourage too much rampant spending, or
raises a certain sector of taxes by a small
amount to accomplish the same effect.
Product continues, but spending becomes
safer and more concentrated, and inflation
tends
to
decrease
as
a
result.

Inflation
issues

Economists often discuss how much effect

any fiscal policy can have on inflation.
Government policies may seem to control
inflation, especially in the short term, but
long term changes are much more difficult
to ascertain. In an increasingly global
economy and a free market economy, the
changes a government can make may be
minimal or ineffective. Consumers tend to
decide
inflation
themselves,
and
government actions may sometimes have
the opposite effects intended.

Poor
Information.
Disincentives
of Tax Cuts.
Other
Components
of

AD.

Increasing
Taxes
to reduce
may
Fiscal policy
will suffer
if the AD
govt
has cause
poor
disincentives
If the government
uses
fiscalthere
policy
its
to
work,
if
this
occurs
will
be is
a
information. (e.g. If the govt believes there
effectiveness
willand
alsoAS
depend
upon
the
fall
in to
productivity
could
However
going
be a recession,
they
will fall.
increase
AD,
higher
taxes
necessarily
reduce
incentives
other
components
of AD,
example
if
however
if do
thisnot
forecast
wasfor
wrong
and the
to
work if the
income
effectthe
dominates.
economy
grew
too fast,
govt
action low,
would
consumer
confidence
is very

cause
inflation).
reducing
taxes may not lead to an
Side
Effects
Public Spending.
Time
Lags. inon
increase
consumer
spending.
Reduced
govt
spending
to Increase
If the govt
plans
to increase
spendingAD
thiscould
can
adversely
as public
take alongeffect
time public
to filterservices
into thesuch
economy
and
transport and education causing market failure and
it may be too late. Spending plans are only set
social inefficiency.
once a year. There is also a delay in
implementing any changes to spending

Coordination between
monetary & fiscal policy
Fiscal policyandmonetary policyare the two
tools used by the State to achieve its
macroeconomicobjectives.
The fiscal policies have a direct impact on
the goods market and the monetary
policies have an direct impact on the asset
markets; since the two markets are
connected to each other via the two macro
variables output and interest rates, the
policies interact while influencing output and
interest rates.

Coordination between
monetary & fiscal policy

GROUP 4

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