MONETARY AND FISCAL POLICY

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Sequence of Presentation

Monetary & Fiscal Policies DefinedWhat do these aim at?Tools of Monetary & Fiscal PoliciesKinds of policies to be pursuedThe best policy, if any?Policies pursued in Pakistan and their impact on

economy

Monetary Policy

Definition

The regulation of the money supply and interest rates by a central bank, such as the State Bank in Pakistan, in order to control inflation and stabilize currency. Monetary policy is one of the two ways the government can impact the economy. By impacting the effective cost of money, the State Bank can impact the business by creating Effective Demand

Fiscal Policy • Measures employed by governments to stabilize the

economy, specifically by adjusting the levels and allocations of taxes and government expenditures. When the economy is sluggish, the government may cut taxes, leaving taxpayers with extra cash to spend and thereby increasing levels of consumption. An increase in public-works spending may likewise pump cash into the economy, having an expansionary effect. Conversely, a decrease in government spending or an increase in taxes tends to cause the economy to contract

Fiscal Policy

• In economics, fiscal policy is the use of government expenditure and revenue collection (taxation) to influence the economy.

• Fiscal policy can be contrasted with the other main type of macroeconomic policy, monetary policy, which attempt to stabilize the economy by controlling interest rates and the money supply.

What do these Policies aim at? Both Monetary & Fiscal policies aim at Low

Inflation, Employment, Foreign Exchange stabilityand Growth of national economy.

Monetary policies maintains balance in money supply, thereby containing the inflation to a desired level, whereas

Fiscal policies stimulate or regulate overall economic activities as per national policies.

Objective of Monetary Policy

Monetary policy rests on the relationship between the rates of interest in an economy, that is, the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment.

Tools of Monetary Policy

Major available tools are:-

Open Market Operations;Reserve requirement; Discount rates variation as a source of last

resort; andPolicy directives or administrative measures

Tools of Fiscal policyThe two main instruments of fiscal policy are :-Government Expenditure & Taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy:

• Effective Demand andthe level of economic activity;

• The pattern of resource allocation; • The distribution of income.

Kind of Policies to be pursued

There is no formulae or standard prescription as to policy option.

Contractionary ( tight monetary policy) and Expansionary (liberal monetary policy), or Frequently adjustable policies or neutral

policies.

Do these policies succeed in isolation? Monetary y & Fiscal policies produce desired

results only if these are in sync with each other. For success of any Monetary policy,

independence of Central bank is a precondition. Political expediencies of national government

may defeat the desired objective of both monetary as well as fiscal policies.

Crowding out credit for private sector may hamper the Effective Demand in the economy, therefore may not create impetus to the economy.

The best policy, if any?

Suffice to say that only that policy or combination of those policies which ensure sustained economic growth & employment without increasing inflation can be termed as successful policy (policies).

At times external shocks create insurmountable pressures in effective implementation of sound policies, this is more so in case of developing economies.

Policies being pursued in Pakistan

In Pakistan Central Bank ( State Bank) never enjoyed enough autonomy to pursue independent Monetary Policies, resulting in partial success whenever it targeted the inflation.

Unlike US, Pakistan has no legislative cap on budget deficit, which allows free hand to disregard deficit limits, conducive for growth.

Political expediencies, rather than prudent economic policies regulate our decisions.