Assignment on Macroeconomics Shammy

8/3/2019 Assignment on Macroeconomics Shammy

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Assignment on Macroeconomics-202(Fiscal Policy & Monetary Policy)

Submitted to:Syed Shah Saad Andalib

Lecturer in macro economics.

Bangladesh University of Business & Technology

Submitted by:Aysha Haider

ID: 40, Sec: 02, Intake: 20th BBA.

Bangladesh University of Business & Technology

Submission date: 03/01/2011


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SL. No: Name of Topic Page. No:

1 Fiscal Policy & Monetary Policy 3

2 Fiscal Policy 3

3 Mathematically Example of Fiscal policy 4-5

4 Monetary Policy 6

5 Types of monetary policy 7

6 Importance of Monetary Policy 8

7 Fiscal Policy V/S Monetary Policy - - The Difference 9

8 Three possible positions of fiscal policy 10


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Fiscal Policy & Monetary Policy

In 1936 Jhon Maynhord Keynes wrote a book General theory of employment interest &

money for reducing unemployed rate. He gives two policies they are -

Fiscal policy &Monetary policy

Fiscal Policy

Economy depends on investment position. If investment decreases then the economyfalls. On the other hand when investment increases then the economy goes to a good position.Fiscal policy deals in govt. spending and revenue collection by the way of tax. Whereas

Monetary Policy is a process which controls the demand and supply of money. Fiscal policyis changes in the taxing and spending of the federal government for purposes of expanding orcontracting the level of aggregate demand. In a recession, an expansionary fiscal policyinvolves lowering taxes and increasing government spending. In an overheated expansion,acontractionary fiscal policy requires higher taxes and reduced spending. According toKeynes, a recession requires deficit spending and an overheated expansion requires a budgetsurplus.

We have, Y= C+I+G

Where, C=C0+CY

Y= C0+CY+I+GThere, Y= Income

C= Consumption

I= Investment

G= Govt. Spending

C0= Autonomous Consumption

CY= Marginal propensity to consume.


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Mathematically Example of Fiscal policy:

Given, C= 100+0.8yd

T= 0.2y

I= 40

G= 50

1. What will be national income? Show the effect of the national income if tax ratechange to 0.18y

2. If national income is 500 then compute the disposable income.3. If disposable income is 400 then find the tax rate.1)We know, Y= C+I+G Y= (100+0.8Yd)+I+G Y= 100+0.8(Y-T)+I+G [Yd= Y-T] Y= 100+ 0.8Y-0.8T+I+G Y= 100+0.8Y-0.8(0.2Y)+40+50 100+0.64Y+90 Y-0.64Y= 190 Y(1-0.64)= 190 Y=

Y=

Y= $ 527.782)Y=C+I+G Y=100+0.8Yd+I+G 500=100+0.8Yd+40+50 500-190=0.8Yd 0.8Yd= 310 Yd=

Yd= 387.53)Y=C+I+G & We know, Y=100+0.8Yd+40+50 Yd=Y-T Y=100+0.8*400+90 => 400= 510-T Y=190+320 => 400-510= -T Y=510 => T= 110 ANS


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If, C0= 70

I= 20

G= 10 & C= 0.8

Then, Y= C0+CY+I+G

Y- CY= C0+I+G Y(1-C)= C0+I+G Y=

Y=

Y=

Y= 500In this position everything is perfect but when the investment will reduce then the effect

goes to an economy. If the investment reduces from 20 to 10 then the situation is less.

Y=

=

=

= 450.

In this position the economy is decreasing but the govt. can take step in this position.

Govt. has to invest more in the market. When govt. spending increases from 10 to 20 then

they can solve the problem.

Y=

=

= 500

By this fiscal policy taken by the govt. can solve the problem arise in the economy. This

is possible because money goes from on hand to another hand with the following chain

relationship.

10+8+6.4+5.12+.

10+ (1+0.8) + (10*0.8*0.8) + (10*0.8*0.8*0.8) + 10 + (1+0.8+0.82+0.83+0.84+.) 10*1/1-0.8 10/0.2 50 Indicates that (when people earn $10 then they spend $8).


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Monetary Policy

When the interest rate is high then money demand is low & when the interest rate islow then the money demand is high. Therefore, the investment of macroeconomic policies of

monetary policy which is conducted through the management of the nations, money, credit &

Banking system. This tool is actually used to control the money circulation.

0 0 money

From the above fig. we can see that when interest rate decreases then demand of

money increases. & when interest rate increase then the demand of money falls. It is also seen

that when interest rate is low then the investment of economy increases. When interest rate is

high then investment decreases. For instance money supply increases result the money supply

shift to the right side. Consequently interest rate decreases to increases the investment.

Monetary policy is the process by which the government, central bank, or monetary

authority of a country controls (i) the supply of money, (ii) availability of money, and (iii) cost

of money or rate of interest, in order to attain a set of objectives oriented towards the growth

and stability of the economy.

Monetary policy is generally referred to as either being an expansionary policy, or

a contractionar policy, where an expansionary policy increases the total supply of money in

the economy, and a contractionary policy decreases the total money supply. Expansionary

policy is traditionally used to combat unemployment in a recession by lowering interest rates,

while contractionary policy involves raising interest rates in order to combat inflation.


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Types of monetary policy

In practice, all types of monetary policy involve modifying the amount of base currency

in circulation. This process of changing the liquidity of base currency through the open sales

and purchases of (government-issued) debt and credit instruments is called open market

operations.

Constant market transactions by the monetary authority modify the supply of currency

and this impacts other market variables such as short term interest rates and the exchange

rate.

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.

Monetary Policy: Target Market Variable: Long Term Objective:

Inflation TargetingInterest rate on overnight

debtA given rate of change in the CPI

Price Level

Targeting

Interest rate on overnight

debtA specific CPI number

Monetary

AggregatesThe growth in money supply A given rate of change in the CPI

Fixed Exchange

Rate

The spot price of the

currencyThe spot price of the currency

Gold Standard The spot price of goldLow inflation as measured by the gold

price

Mixed Policy Usually interest rates Usually unemployment + CPI change


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Importance of Monetary Policy

The growing importance of monetary policy and the diminishing role played by fiscal policingeconomic stabilization efforts may reflect both political and economic realities.

Fighting inflation requires government to take unpopular actions like reducing spending or

raising taxes, while traditional fiscal policy solutions to fighting unemployment tend to be

more popular since they require increasing spending or cutting taxes. Political realities, in

short, may favor a bigger role for monetary policy during times of inflation.

One other reason suggests why fiscal policy may be more suited to fighting unemployment,

while monetary policy may be more effective in fighting inflation. There is a limit to howmuch monetary policy can do to help the economy during a period of severe economic decline,

such as the States encountered during the 1930s. The monetary policy remedy to economic

decline is to increase the amount of money in circulation, thereby cutting interest rates. But

once interest rates reach zero, the Fed can do no more. The United States has not encountered

this situation, which economists call the "liquidity trap," in recent years, but Japan did during

the late 1990s. With its economy stagnant and interest rates near zero,

many economists argued that the Japanese government had to resort to more aggressive fiscal

policy, if necessary running up a sizable government deficit to spur renewed spending and

economic growth.


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Fiscal Policy V/S Monetary Policy - - The

Difference

Monetary Policy is being implemented by the central bank i.e. the RBI where as the

Fiscal policy decisions are set by the National Govt. Both these policies are adopted to control

the economic growth of the country.

A monetary policy is expected to improve the economy's rate of growth of output

(which is measured by GDP. Tight or restrictive monetary policy is designed to slow the

economy in the future to offset inflationary pressures. Likewise, fiscal policies, tax cuts, and

spending increases are normally expected to stimulate economic growth in the short run,

while tax increases and spending cuts tend to slow the rate of future economic expansion.

Fiscal Policy and Monetary Policy both are the major terms used in the economics and

both deal in the overall demand and supply of India.

Fiscal policy deals in govt. spending and revenue collection by the way of tax. Whereas

Monetary Policy a process which control the demand and supply of money.

Fiscal Policy can affect monetary policy. Fiscal policy can affect the inflationary rates also

through its effect on aggregate demand. For E.g. As now we know that fiscal policy deals in

govt. spending and taxation, so if govt. start levying extra tax then the consumer will have less

money in their hands and thus less spending. Less spending means less demand that means

more supply and less demand which will ultimately result in cheaper goods and thus the

inflation rates will start to lower. This is only the one case I have explained which can be in

either case as well. That means if more liquidity is in the market then more money will be

there in the hands of the consumer which will surge the demand and when too much of money

is running for too few goods this will result in higher prices of the goods and thus higher

inflation.


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For fiscal policy there are three possible

positions:

1. Neutral Position

2. Expansionary Position

3. Contractionary Position

1) A Neutral position applies when the budget outcome has neutral effect on the level of

economic activity where the govt. spending is fully funded by the revenue collected from the

tax.

2) An Expansionary position is when there is a higher budget deficit where the govt. spending

is higher than the revenue collected from the tax.

3) An Contractionary position is when there is a lower budget deficit where the govt. spending

is lower than the revenue collected from the tax.

[Note that expansionary monetary policy is commonlycalled "easy money" while contractionary monetarypolicy is called "tight money". Other terms are alsoused].

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Assignment on Macroeconomics Shammy