Economics for Business Macroeconomics Monetary policy Fiscal - - PowerPoint PPT Presentation

Economics for Business –Macroeconomics

• Monetary policy
• Fiscal policy
• Supply side policies

Monetary Policy

• This is a demand side policy designed to influence the aggregate demand of the economy.
• Involves changing interest rate & money supply.
• Usually controlled by the monetary policy committee of the central bank.
• Ideally should be independent from the government

and is usually used to control the inflation level in the economy.

Types Of Monetary Policy

• Expansionary Monetary Policy – Involves reducing interest rates & increasing

money supply in the economy. Causes an increase in aggregate demand.

• Contractionary Monetary Policy - Involves increasing interest rates &

decreasing money supply in the economy. Causes an decrease in aggregate demand.

Interest Rates

• The price for the use of money
• The cost of borrowing money
• The reward for lending money

Interest can also be viewed as :

• A return for sacrificing liquidity
• A fee for risk
• Compensation for inflation

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Nominal And Real Interest Rates

• Nominal rates are the % paid on the loaned amount
• Real rates adjust for inflationary effects

Real Rate = Nominal Rate- Inflation Rate 2% = 6%

• 4%
• Lenders make decisions on the real rate

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Factors Affecting Interest Rates

• 1. Supply of funds (savings/deposits)
• Domestic savings(by household & firms)
• Foreign loans
• Monetary policy’s influence on supply of cash
• 2. Demand for funds (borrowing)
• By firms for investment
• By households for consumption
• By governments to finance budget deficits
• 3. Inflation

Savers demand real returns Lenders will not lend if real rates are too low Rates reflect expected inflation

Interest rates are determined by demand and supply of funds in money markets

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Factors Affecting Interest Rates

• 4. Level of
• verseas rates
• International investors have a global approach - look for highest returns

5.Monetary policy - market operations

• By buying or selling government securities the Central Bank

can move rates

• Cash rates move first

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Effects Of High IR – Contractionary Monetary Policy.

Consumers:

• Consumption discouraged

(E.G. Higher credit card interest, higher home loan repayments)

• Savings ↑

Business Investment discouraged (Higher repayments/costs of loans, projects less profitable)

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Effects of High Interest Rates Cont.

• Less consumption
• Less investment
• More savings
• Less AD and reduced economic activity

Contraction of economy

• Higher unemployment
• Lower inflation (lower demand pressure)
• Lower GDP growth

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Fiscal Policy

• This is a demand side policy designed to influence the aggregate demand of the

economy.

• Involves changing taxation & govt. Spending.
• Controlled by the government budget
• Used to achieve the government objectives

Types Of Fiscal Policy

• Expansionary Fiscal Policy – Involves reducing taxes & increasing govt.

Spending in the economy. Causes an increase in aggregate demand.

• Contractionary Fiscal Policy - Involves increasing taxes & decreasing
• govt. Spending in the economy. Causes an decrease in aggregate

demand.

A statement setting out the govt. Estimated expenditure (G) and revenue (T) for the forthcoming financial year.

It contains details on:

• 1. Recent economic performance
• 2. Overall stance or aim of policy
• 3. Specific planned measures
• 4. Expected effects

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The Budget

• Allocation of resources
• To affect output and resource use inthe economy

How?- Taxes on selected goods and services E.G. Alcohol, cigarettes

• Subsidies, tax concessions

E.G. Health care, education, child care

• Govt. Spending on public goods

E.G. Defense

Functions of Fiscal Policy

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• Redistribution Of Income
• To Influence The Way In Which Goods And Services Are Shared

Aim? Less Income Inequality How? rates for

• Different tax rates e.G. Higher tax higher

income earners

• Social security, welfare payments
• Spending on health, education, etc.

Functions of Fiscal Policy

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Direct Tax

• Paid directly from the tax payer to the govt

E.G. Income tax, company tax Indirect Tax

• Tax is collected from one source but the burden is

passed on to another (consumer) E.G. Excise on petrol, Tariff

Direct And Indirect

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Financing a BudgetDeficit

Deficit : Govt. Spending > Tax Revenue

• Used to stimulate economic activity
• Govt. is spending more than it receives
• Needs to finance the difference – the Public Sector

Borrowing Requirement (PSNCR)

• Federal, states, local govt. plus government

authorities and govt. businesses Adds to Public (National) Debt

Borrowing from domestic economy

• Borrowing by govt. Uses a proportionof domestic

savings

• Funds available for firms to borrow reduced
• Competition for funds puts upward pressure
• n interest rates

Methods of Financing the Budget Deficit

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Borrowing from overseas

• Foreign banks, foreign investors
• Adds to foreign debt
• Can cause currency to appreciate
• Repayment of interest can ↑ current a/c deficit

Borrowing from the reserve bank

• Central bank provides funds for government to spend
• Printing money

Methods of Financing the Budget Deficit

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Current National Debt is around $55 Billion.

May stimulate economic activity

• Keynesian policy concept
• Injection of demand
• Multiplier effect
• Should be used when economic activity is below

target growth rate.

Positive Aspects of Budget Deficit

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• Deficits may be inflationary
• Crowding out effect
• Pressure on interest rates
• Increased size of govt. Sector at the expense of private sector
• Debt accumulated for future

Negative Aspects of Budget Deficits

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• Used when economic activity is higher than desired
• boom
• Can be used to increase national savings
• Impound the surplus – keep excess funds out of circulation
• Reduce national debt – pay back govt. Debt by buying back

securities from private sector

• Repay foreign debt – the govt. Component

Budget Surplus

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