2. Explain, with examples what is meant by:
a. Fiscal policy
b. Monetary policy
A. Fiscal policy
What is Fiscal policy?
Fiscal policy is a government policy which specially designed to control the inflation
in domestic market and also the unemployment level in the country. It controls the
unemployment level and inflation by adjusting the government levels of spending for
examples, adjusting the tax rates and others government spending.
Examples of Fiscal policy
Example 1
In Keynesian macroeconomics, the point is unemployment. Understanding
unemployment as an excess supply of labour, and considering unemployment as a
social problem, the point is 1) to understand how such a problem can arise in a market
economy, and 2) to suggest how the problem might be solved or made less serious.
Up until now we have been concerned with diagnosis -- how can the problem arise?
But we have come to a point at which we can prescribe. The prescription will, of
course, be very tentative and preliminary -- we may want to change it as we learn
more. But we can see something that might be done.
The prescription is addressed to the national government. Keynesian economics
understands unemployment as a macroeconomic problem, a problem of the economic
system as a whole, so it must be addressed by the one agency that can have an impact
on the economic system as a whole: the national government.
What we have just seen is that a change in government purchases of goods and
services can influence the equilibrium income in the model economy. An increase in
income would mean (ceteris paribus) that more people would be employed to produce
the income. So it could make sense for the government to spend more money in order
to stimulate production.
A program of public works, for example, could hire the unemployed to build new
roads, parks and camps and public buildings, and even interview old people and write
the local history of their communities. The Works Progress Administration did all of
these things in the U. S. in the 1930's. (In its recession of the 1990's, Japan, too,
turned to public works to increase income.) By hiring the unemployed, such a public
works program would make the people it hired better off; but it would do more than
that. It would have a multiplier effect. The people hired for the public works would
spend most of their income, and that would create income for still other people, who
would in turn spend most of their income and create still more income for still other
people. That's the way the multiplier works. And, so long as the new income is being
produced by people and resources that would otherwise be unemployed, it's a no-lose
situation -- no other goods and services need be sacrificed in order to increase the
incomes of the formerly unemployed. (At least, that's the way it would work in the
Keynesian model economy. The real world is, as always, more complex and
frustrating).
Public works projects designed to increase employment would be an example of
"fiscal policy."
Example 2
The government has introduced a lower starting rate of income tax for lower income earners.
This is designed to provide an incentive for people to work extra hours and keep more of
what they earn.
Changes to the tax and benefit system also seek to reduce the risk of the ‘poverty trap’ –
where households on low incomes see little net financial benefit from supplying extra hours
of their labour. If tax and benefit reforms can improve incentives and lead to an increase in
the labour supply, this will help to reduce the equilibrium rate of unemployment and thereby
increase the economy’s non-inflationary growth rate.
Example 3
Lower rates of corporation tax and other business taxes can stimulate an increase in business
fixed capital investment spending. If planned investment increases, the nation’s capital stock
can rise and the capital stock per worker employed can rise.
The government might also use tax allowances to stimulate increases in research and
development and encourage more business start-ups. A favourable tax regime could also be
attractive to inflows of foreign direct investment.
B. Monetary policy
What is Monetary policy?
Government policy to appoint a central bank to control the amount of money supply
that circulating in market.
Function of Monetary policy
Examples of Monetary policy
Importance of Monetary policy
http://www.investopedia.com/articles/04/051904.asp
http://www.buzzle.com/editorials/8-10-2004-57690.asp
http://faculty.lebow.drexel.edu/mccainr/top/prin/txt/fiscal/fiscal.html
http://tutor2u.net/economics/revision-notes/a2-macro-fiscal-policy-effects.html