fiscal policy is the use of government revenue collection (mainly taxes)
and expenditure (spending) to influence the economy.[1] According to
Keynesian economics, when the government changes the levels of taxation and government spending, it influences aggregate demand and the level of economic activity. Fiscal policy can be used to stabilize the economy over the course of the business cycle.[2] The two main instruments of fiscal policy are changes in the level and composition of taxation and government spending in various sectors. These changes can affect the following macroeconomic variables, amongst others, in an economy: 1. Aggregate demand and the level of economic activity; 2. Savings and Investment in the economy 3. The distribution of income The three main stances of fiscal policy are: neutral fiscal policy is usually undertaken when an economy is in equilibrium. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions. Contractionary fiscal policy occurs when government spending is lower than tax revenue, and is usually undertaken to pay down government debt.
Monetary policy is the process by which the monetary authority of a
country controls the supply of money, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency. Further goals of a monetary policy are usually to contribute to economic growth and stability, to low unemployment, and to predictable exchange rates with other currencies. Monetary economics provides insight into how to craft optimal monetary policy. Monetary policy is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in order to avoid the resulting distortions and deterioration of asset values. Monetary Policy:
Target Market Variable:
Long Term Objective:
Inflation Targeting
Interest rate on overnight debt
A given rate of change in the CPI
Price Level Targeting
Interest rate on overnight debt
A specific CPI number
Monetary Aggregates
The growth in money supply
A given rate of change in the CPI
Fixed Exchange Rate
The spot price of the currency
The spot price of the currency
Gold Standard
The spot price of gold
Low inflation as measured by the gold price
Mixed Policy
Inflation targeting is an economic policy in which a central bank
estimates or decides for a medium-term target inflation rate and makes public this "inflation target". Then the central bank attempts to steer with short-term instruments at its own discretion actual inflation towards this target through the use of interest rate changes and other monetary tools. Price level targeting is a monetary policy that is similar to inflation targeting except that CPI growth in one year over or under the long term price level target is offset in subsequent years such that a targeted price-level is reached over time, e.g. five years, giving more certainty about future price increases to consumers. Under inflation targeting what happened in the immediate past years is not taken into account or adjusted for in the current and future years. Monetary aggregates . This approach was refined to include different classes of money and credit (M0, M1 etc.).
fixed exchange rate, sometimes called a pegged exchange rate, is a
type of exchange rate regime where a currency's value is fixed against either the value of another single currency, to a basket of other currencies, or to another measure of value, such as gold. There are benefits and risks to using a fixed exchange rate. A fixed exchange rate is usually used in order to stabilize the value of a currency by directly fixing its value in a predetermined ratio to a different, more stable or more internationally prevalent currency (or currencies), to which the value is pegged. In doing so, the exchange rate between the currency and its peg does not change based on market conditions, the way floating currencies will do. This makes trade and investments between the two currency areas easier and more predictable, and is especially useful for small economies in which external trade forms a large part of their GDP(Gross Domestic Product). A fixed exchange-rate system can also be used as a means to control the behavior of a currency, such as by limiting rates of inflation. Gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. Three types may be distinguished: specie, exchange, and bullion. 1. In the gold specie standard the monetary unit is associated with the value of circulating gold coins or the monetary unit has the value of a certain circulating gold coin, but other coins may be made of less valuable metal. 2. The gold bullion standard is a system in which gold coins do not circulate, but the authorities agree to sell gold bullion on demand at a fixed price in exchange for the circulating currency. 3. The gold exchange standard usually does not involve the circulation of gold coins. The main feature of the gold exchange standard is that the government guarantees a fixed exchange rate to the currency of another country that uses a gold standard (specie or bullion), regardless of what type of notes or coins are used as a means of exchange. This creates a de facto gold standard, where the value of the means of exchange has a fixed external value in terms of gold that is independent of the inherent value of the means of exchange itself. Policy tools Monetary policy uses three main tactical approaches to maintain monetary stability: Money supply. The first tactic manages the money supply. This mainly involves buying government bonds (expanding the money supply) or selling them (contracting the money supply). In the Federal Reserve System, these are known as open market operations, because the central bank buys and sells government bonds in public markets. Most of the government bonds bought and sold through open market operations are short-term government bonds bought and sold from Federal Reserve System member banks and from large financial institutions .When the central bank disburses or collects payment for these bonds, it alters the amount of money in the economy while simultaneously affecting the price (and thereby the yield) of short-term government bonds. The
change in the amount of money in the economy in turn affects interbank
interest rates. Money demand. The second tactic manages money demand. Demand for money, like demand for most things, is sensitive to price. For money, the price is the interest rates charged to borrowers. Setting bankingsystem lending or interest rates (such as the US overnight bank lending rate, the federal funds discount Rate, and the London Interbank Offer Rate, or Libor) in order to manage money demand is a major tool used by central banks. Ordinarily, a central bank conducts monetary policy by raising or lowering its interest rate target for the interbank interest rate. If the nominal interest rate is at or very near zero, the central bank cannot lower it further. Such a situation, called a liquidity trap,can occur, for example, during deflation or when inflation is very low. Banking risk. The third tactic involves managing risk within the banking system. Banking systems use fractional reserve banking to encourage the use of money for investment and expanding economic activity. Banks must keep banking reserves on hand to handle actual cash needs, but they can lend an amount equal to several times their actual reserves. The money lent out by banks increases the money supply, and too much money (whether lent or printed) will lead to inflation. Central banks manage systemic risks by maintaining a balance between expansionary economic activity through bank lending and control of inflation through reserve requirements. These three approaches -- open-market activities, setting bankingsystem lending or interest rates, and setting banking-system reserve requirements to manage systemic risk -- are the "normal" methods used by central banks to ensure an adequate money supply to sustain and expand an economy and to manage or limit the effects of recessions and inflation. These "standard" supply, demand, and risk management tools keep market interest rates and inflation at specified target values by balancing the banking system's supply of money against the demands of the aggregate market. Unconventional monetary policy at the zero bound Other forms of monetary policy, particularly used when interest rates are at or near 0% and there are concerns about deflation or deflation is occurring, are referred to as unconventional monetary policy. These include credit easing, quantitative easing, and signaling. In credit easing, a central bank purchases private sector assets to improve liquidity and improve access to credit. Signaling can be used to lower market expectations for lower interest rates in the future. For example, during the credit crisis of 2008, the US Federal Reserve indicated rates would be low for an extended period, and the Bank of Canada made a conditional commitment to keep rates at the lower bound of 25 basis points (0.25%) until the end of the second quarter of 2010.
Investment Preference, Risk Perception, and Portfolio Choices Under Different Socio-Economic Status: Some Experimental Evidences From Individual Investors