Fiscal and monetary policy, objectives, anti-inflationary fiscal policy Fiscal Policy The most important instrument of government

intervention in the economy Fiscal Policy is the decision of the government about: How to earn revenue and gather resources from various sources For what to spend those earnings and resources How much to spend and When to spend There are two sides of fiscal policy

Earnings: Revenue and Resources

Why does the government need revenue? To maintain its daily activities, i.e. to run the government

 To ensure protection for the helpless To provide necessary services to people that otherwise nobody would provide (Market failure) To ensure development of the country To build buffer against risk! Where does the revenue come from? Tax revenue Direct: income tax, wealth tax etc. Indirect: VAT, tariff, excise duty etc. Non-Tax revenue Fees & charges: registration, sales of forms, stamps etc. Fines: mobile court fines, police fines etc. Printing of money

Where does the government keep its revenue? The governments account is maintained by the Treasury which is located at Bangladesh Bank The account in which all these revenues are deposited is called the Consolidated Fund Consolidated Fund was created under Article 84 of our constitution Resources from other sources Grants Loans from Domestic sources Treasury bills/bonds

 savings schemes borrowing from the banks Foreign sources Bilateral Multilateral Revenue trend in Bangladesh Revenue as percent of GDP is increasing Around 80 percent of public revenue in Bangladesh is derived from tax sources.

Public Expenditure: Types Government spending may be broadly classified into two categories Revenue expenditure Development expenditure Revenue expenditure mainly includes government employees salary, benefits and establishment costs. Development expenditure mainly includes money spent on development activities. Is revenue expenditure good or bad? In which way public expenditure of Bangladesh moving? The government spends huge amounts of money on building socio-economic and physical infrastructure human resource development and poverty alleviation. Besides, the government has to incur expenditure for: Administrative

 welfare and other service oriented activities Principles objectives of Fiscal Policy: To mobilize resources for economic growth, especially for the public sector To promote economic growth in the private sector by providing incentives to save and invest. To restrain inflationary forces in the economy in order to ensure economic stability To ensure equitable distribution of income and wealth so that fruits of economic growth are fairly distributed. Fiscal Policy and Bangladesh Main objectives: To ensure macroeconomic stability To promote economic growth To develop a mechanism for equitable distribution of national income Times Gone By/legacy/background In the decades of 1980s, the fiscal policy focused on reconstruction and rehabilitation work. During that period fiscal policy failed to play significant role to ensure macroeconomic stability. In the 1990s, major changes were come through the structural adjustment and privatization process. Value Added Tax (VAT) was introduced in 1991. The overall budget deficit was 8.4% of GDP during the 1980s and came down to under 6% in the decade of 2000. Current budget deficit is 5.1% of GDP.

Definition of monetary policy Monetary policy is the term used by economists to describe ways of managing the supply of money in an economy. Monetary Policy is the management of money supply and interest rates by central bank to influence prices and employment for achieving the objectives of general economic policy. Monetary policy works through expansion or contraction of investment and consumption expenditure. According to Paul Einzig Monetary policy includes all monetary decisions and measures irrespective of whether their aims are monetary and non-monetary, and all non-monetary decisions and measures that aim it affecting the monetary system. According to Harry G. Johnson Monetary policy employing the central banks control of supply of money as an instrument for achieving the objectives of general economic policy. From the above discussion monetary policy may be defined as the central banks policy pertaining to the control of the availability, cost and use of money and credit with the help of monetary measures in order to achieve specific goals. The Broad Discussion of Monetary Policy Objective Price stability Inflation distorts economic calculations and expectations while deflation creates depression in the economy. Thus price stability should be the main aim of monetary policy. Price stability promotes business confidence, makes economic calculation possible, controls business cycle and introduces certainty in economic life. Be that as it ma, it must be admitted that price stability does not be necessarily mean absolute constancy of price level. A very slow rising price level (or mild inflation) may have all the virtues of a stable price level, which can contribute more directly to economic growth. Exchange Stability Maintenance of stable exchange rates is an essential condition for the creation of international confidence and promotion of smooth international trade on the largest scale possible. A restrictive monetary policy trends to reduce a countrys balance of payment defect in the following ways: 1. It tends to reduce demanding the country, which in turn tends to reduce the demand for imports as well as for domestic goods. 2. Reduction in domestic demeans holds down the rate of inflation or reduces prices which makes imported articles less attractive and makes the defect countrys exports more attractive to foreigners. Thus, import is curtailed and export expanded.

3. Under dear money policy, higher interest rates make it less attractive for foreign countries to borrow from the defect country and induce them to invest there. Full Employment In under developed countries, the full employment objective is more crucial, because such economies have both unemployment and under employment open and disguised. In less developed countries, though full employment cannot be achieved within a short period, the monetary policy should try to achieve at least a near full employment situation.

Full employment objective of monetary policy has certain far-reaching beneficial effects: 1. Full employment can maintain a high level of aggregate effective demand, and thereby can iron out cyclical fluctuations, stagnation and under consumption trap. 2. Before full employment is achieved, investment can be made in excess of saving and a price increase in a slow rate is permissible. These will give incentive for the fuller utilization of resources and for higher income, output and employment. 3. The creation of full employment condition will almost automatically, lead to the maximization of social and economic welfare of the society because the resources would be used fully and effectively. 4. Full employment will, according to Einzig, lead to increase productivity of workers, because the workers are not sacred of unemployed situation. The relation between labor and capital would be ideal and all-round efficiency will increase. Economic Growth This comparatively a recent object of monetary policy. If refers to the growth of real income or output per capita. Monetary policy can contribute to economic growth in the following ways: 1. It can maintain a balance between monetary demand and supply of goods, and it can also supply money is such a way as is consistent with the supply of goods and services.

2. It can create atmosphere in which a higher rate of saving and investment would be generated. 3. Monetary policy minimizes fluctuation in business activity and prices. 4. It creates stability for growth.

5. It influences the rate of interest, investment and the use of credit in the most productive channels in the economy. 6. When necessary, it expands credit and when it is not necessary, if restricts the flow of credit. It creates saving intuitions and monetization in the saving of the community towards productive investment. 7. Monetary policy gives guidance, looks after monetization in the unorganized sector and controls the actives of the financial intermediaries. Neutrality of Money Neutrality of money indicates a situation in which changes in the quantity of money occurs in such a way as to cause a proportionate change in the equilibrium prices of commodities, and the equilibrium rate of interest remains unchanged. If money is neutral, an increase or decrease in the quantity of money will both produce and disturbing effects in the economy. Neutrality of money does not mean constant money supply, means that the effect of changed money supply on real variables in the economy would be neutral. Balance of Payment Equilibrium Balance of payment equilibrium condition is a position at which a country repaid its debts and has attained an adequate reserve at zero balance over time. This main objective on monetary policy has become significant in the pose-period. It is realized that the existence of balance of payment deficit seriously reduces the ability of an economy to attain other objectives. So, monetary policy must make into consideration the international payment problem.

Limitation of Monetary Policy in Developing Country In developing country, monetary policy suffers from the following limitations 1. In under developing countries, and capital markets are narrow and unorganized. Hence, the credit control mechanisms like open market operation, bank rate, etc. cannot be effective. 2. Commercial banks keep cash reserve in excess of legal reserve requirements. In such a context, the purpose of the higher bank rate becomes defeated. The commercial banks do not go to the central bank when the latter expects them to geo. Similarly, in this situation, the instrument of reserve requirement does not function properly. 3. A narrow bill market makes the discount rate ineffective.

4. The existence o non-bank financial intermediaries also makes the credit control measures of the central bank ineffective, because, such intermediaries like sahukar, village money lender, etc. cannot be brought under the control and regulation of the banking system. 5. For all these reasons, monetary policy for controlling inflation in backward countries has not been very effective.

6. In order developed countries, banking habits are also underdeveloped which hampers the effectiveness of monetary policy seriously. 7. In backward countries, monetary expansion generally leads to increase imports, unfavorable balance of payments and loss of gold reserve, etc. 8. By its nature, monetary policy is not effective in the short run. 9. The role of monetary policy is not compulsive but permissive. This seriously limits the efficiency of monetary policy in backward countries. 10. In under developed society where liquidity trap is in existence monetary policy cannot work efficiently. 11. Administrative honesty and firmness are not very rigorous in less developed countries which reduce the efficiency of monetary policy a policy a lot. 12. Lastly, the lag between the decision about a particular policy and its implementation also hinders the monetary policy in its success. Here we found that monetary policy suffers from various limitations in the developing country. So, it should be supplemented by fiscal policy to make it effective. Despite this information, monetary policy sets the tone of economic development in recent years. What is Monetary Policy? It is the governments decision about how much money to supply to the economy. Monitory Policy is concerned with the measures take to regulate the volume & supply of money, cost and availability of credit as well as other money substitutes in the economy. Monetary policy plays important role for overcoming depression and inflation. Central bank implements this policy. Monetary Policy and Bangladesh Main objectives: (According to the Bangladesh Bank Order 1972)

To regulate currency and reserves To manage the monetary and credit system To preserve the per value of domestic currency To promote and maintain a high level of production, empowerment and income To faster growth and development of the countrys productive resources in the best national interest.

Goals of Monetary Policy Price stability GDP growth Investment Fight recession Exchange rate stabilization Desired level of unemployment rate Price Stability: for example, price is shooting up and we want to control it

We reduce money supply

Now people have less money at hand

So, people buy less amount of goods

Demand for goods falls

Producers reduce price to maintain sales

Gone by/background/legacy

 In old times, monetary policy was mainly focused on seioniorage with the aim to maintain the value of money Inflation was not a big concern Bank of England created in 1694 During 1870 1920 industrialized nations set up central banks Monetary policy came into question during the great depression mizan128.wikispaces.com

The Two Faces of Monetary Policy

Limitations of Monetary Policy

 Does not work when aggregate demand needs to be stimulated through direct government spending (Great Depression) Works on the economy through indirect channels. Therefore, often suffers from lag to have impact May be dominated by fiscal policy Wrong policy may result in severe damage for the economy Monetary Policy vs. Fiscal Policy If the goals of the two policies do not match, development objective will be damaged. Example: Suppose, Bangladesh is suffering from high inflation and BB wants to reduce it. BB reduces money supply But, national election is close and will be held within a year. So, the ruling party decides to spend more money on safety-net programs and employment generating activities Accordingly, the ruling party sets its fiscal policy so that expenditure goes up.

WHAT ARE THE INSTRUMENTS OF MONETARY POLICY http://www.cenbank.org/Out/EduSeries/Series9.pdf Paper money is issued by the Central Bank on the basis of computation of estimated demand for cash. Monetary policy guides the Central Banks supply of money in order to achieve the objectives of price stability (or low inflation rate), full employment, and growth in aggregate income. The instruments of monetary policy used by the Central Bank depend on the level of development of the economy, especially its financial sector.