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Monetary and Fiscal Policy

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Marianna Kestrel Tabilon

on 27 September 2013

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Transcript of Monetary and Fiscal Policy

Monetary and Fiscal Policy
"Economic Development"
Nature of Economic Policies
Objectives of Economic Policies
Monetary Policies
Ideas and Shortcomings of Monetary Policies
Fiscal Policy
Provision of Social Goods
Fiscal Effect on the Economy
Weaknesses of Fiscal Policies
Coordination Between Monetary and Fiscal Policy

Nature of Economic Policies
These are based on economic theory
These are application of theory or principle
These are formulated to attain specific objectives or solve certain problems
Policy Makers
People with various values, orientations and interests.
Most of them are politicians or top government officials who have been elected by the people.
They are inclined to make policies which ensure their reelection or matters of political expediency rather than economic interest.
Therefore, economic policies are as good as the policy makers. If the policy makers are only after to their friends and relatives, then their policies have adverse effects on the other sectors of the economy.
What is a Good Economic Policy?
It must be stated in broad terms
It must be long range, but flexible to a certain degree.
It must be in writing and easy to understand
It must be widely acceptable.
It must be reasonable.
It must be consistent with the objectives and goals to be attained
It must be communicated to all concerned.
It must be implementable.
It must cover all important relevant aspects.
It must be in accordance with the law.
People-Oriented Policy
-The welfare of the people is always the primary consideration.
Considers their employees as the most important assets. Business Corporations of Japan fashion their policies towards human resource development.
The main program of the government is to improve the quality of life of the people.
Fiscal Policy
* It refers to the revenue and expenditure measures of the public budget.

* It is the use of government spending and taxation to influence the economy.

* Fiscal policy-making involves the voters, president and its cabinet, the legislative body.

* In a democratic society, the needs and wishes of the people are reflected in the budget.
Ex. The need for a public elementary school in a barrio or an irrigation system for the farmers.

The preparation of the budget is done by the president and his cabinet. Budget proposal is submitted to the legislative body for discussion and decision. The task of administering the budget goes to the President and his cabinet.
Fiscal policy is an important tool for managing the economy because of its ability to affect the total amount of output produced—that is the gross domestic product.
Provision of Social Goods
• One area in which free mechanism hesitates to engage in.

• Anti-pollution projects

• Roads and bridges that are not heavily used

• Other infrastructures which do not yield good profits

• Social Goods Generally incur huge investment of funds and yet many of them are not profitable.

• The government is for service and not for profit.

Fiscal Policy Objectives

1. Provision for Social Goods

2. Equitable Distribution of Wealth and income

3. Maintain High Employment

4. Ensure Price Stability

5. Sustain a Satisfactory rate of
economic growth

Fiscal Effect on the Economy
Fiscal policy through its fiscal tools like taxation and government expenditures envisions to perform its functions of allocation, distribution and stabilization in economy.

Proper measures on taxation and government expenditures can stimulate savings, investments, employment, production and income. These can also help redistribute wealth and income and achieve price stability.

The government can encourage investments by giving tax exemptions or reasonable taxes, and by extending the necessary external economies of scale like transportation, communication, electrification, and peace and order.

All these benefits reduce the cost of production of businessmen, which giving them a greater chance of getting better returns or profits of their investments.
Redistribution of wealth and income fairly among the various groups of the society is another function of fiscal policy that the government can attain through appropriate fiscal programs like agrarian reform program, cooperatives development program, housing, education, and health program.
Weaknesses of Fiscal Policies
Fiscal –policy making is more of a political rather than a market process. Many and varied interests do influence fiscal policy making. In general, some of the popular interests are those of the voters, business group, farmers group, workers group, and other special groups.

Needless to say that a good fiscal policy is more concerned about social justice and the equitable distribution of the social and economic resources of society.
Booms and Lags

Under a boom condition, the proper fiscal measures should be to increase taxes and/or decrease government expenditures. But in reality these are difficult to implement. Naturally, people will oppose the increase in taxes. While during a lag, it involves the discussions of problem, the implementation of the appropriate fiscal policy, and its subsequent effects on the economy.

Objectives of Economic Policy
Economic Growth
Full Employment
Economic Freedom
Equitable Distribution of wealth and income
Economic Security
Economic Stability
Monetary Policy
Monetary Policy

-defined by Prof. James Boughton as 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 allocation of credit to its various uses.
Primary Monetary Goals

* To maintain internal and external monetary stability in the Philippines

* To preserve the international value of the peso and its convertibility into other currencies

* To foster monetary, credit and exchange conditions for a balanced and sustainable growth of economy

Major Monetary Tools

* Legal reserve requirement- increase/decrease of the percentage of the reserve deposits of banks as required by the Central Bank

* Open- market operations- purchases and sales of the government securities by the Central Bank

* Moral Suasion- appeal of the Central Bank to the banks to expand/contract their credit or to suspend types of bank credit

Coordination Between Monetary and Fiscal Policy
Both monetary and fiscal policies have the same objective; it is the attainment of greater economic growth.

Hence, there is a need for cooperation and coordination between the two.
Group 4
Ideas on Monetary Policy
* The Keynesians, led by Samuelson, Tobin, and Heller, believe that a free enterprise economy has several inherent limitations. For example, it does not provide social goods, it does not properly allocate resources, and it leads to the unfair distribution of income.

* Furthermore, a free enterprise economy or capitalism cannot balance investments and savings. Thus, business fluctuations are created and this is not good to the economy.

* The followers of John Meynard Keynes consider the active role of the government in stabilizing economic activities. This is fiscal policy which refers t government expenditures, taxation, and borrowings. They believe such government activities or fiscal tools are better than monetary tools in achieving economic stability, resource allocation, and income distribution.

Free Market System is better ...
* On the other hand, the monetarists, headed by Milton Friedman challenged the Keynesian concepts. They believe a free enterprise economy or laissez faire is better for the whole economy. This is also what the classical economists under Adam Smith developed during the later part of 1700’s.
* They stressed that free competition automatically distributes resources efficiently. Through free market mechanism, goods and services are better allocated than through government agencies or interferences in the market system.

* The Monetarists claim that the government decision-making process is bureaucratic, inefficient, and harmful to individual incentives – not to mention the frequent blunders of government policies. Likewise, the centralized decisions of the government destroy individual freedoms.

* To the monetarists, monetary policy is the key determinant of aggregate demand. Through the role of money and price, level of economic activities can be determined. And these thrive better in an environment of free enterprise economy or free market economy. If individuals are free to seek their own interests through competition, they believe this will promote the interests of the whole society.

* And these thrive better in an environment of free enterprise economy or free market economy. If individuals are free to seek their own interests through competition, they believe this will promote the interests of the whole society.

Role Of Money Supply
* Another area of conflict between the Keynesians and Monetarists is the role of money supply in producing changes in the level of notional income. The Keynesian economists believe that monetary policy has an indirect effect on notional income by causing changes in the interest rate which in turn changes consumption and investments.

* On the other hand, the monetarists argue that changes in the money supply have direct effects on the national income. In addition, they claim that stable prices and a steady growth rate of real GNP can only be achieved by allowing the money supply to increase at approximately the anticipated real growth rate of the GNP.

* In contrast, the Keynesians believe that monetary policy can successfully keep the economy on steady growth with low unemployment only when it is combined with appropriate fiscal policies.

Shortcomings of Monetary Policy
* When a monetary or financial problem or need emerges, monetary authorities have to confirm it by gathering facts. These have to be presented and analyzed in order to be able to formulate sound and appropriate monetary policies.

* The whole process takes time, and even longer for the less developed countries with inefficient public administration. Another day is the impact lag which is the time between the implementation of the monetary policy and the time the effects of the policy becomes evident on the various sectors of the economy.

* In view of the conflicting interests of the different groups in the economy, it is not easy to evaluate the effects of the monetary policies.

* Furthermore, a monetary policy is very weak during deep depression. Even if banks offer the lowest possible interest rate to investors, still there are no takers because the expected returns of investment are even lower than the interest rate. As a good example, the Great Depression in the United States in 1930’s, monetary policies miserably failed to accomplish their missions.
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