Chapter 9

Public Policies
 Chapter Objectives
 Understand the concepts of Fiscal policy
( Expansionary and Contractionary)
 Understand the Monetary (Expansionary,
Contractionary and Tools)

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 1. Fiscal Policy
 refers to the use of government taxation and
expenditure to influence the country’s spending,
employment and price levels.
 Also refers to the regulation of the level of
government spending, taxation and public debt.
 Three Options:
1. Increase government spending
2. Reduce taxes
3. Use some combination of the two

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 Objectives of Fiscal Policy
1. Securing efficient allocation of economic
resources
2. Attaining and maintaining full employment
3. Accelerating the rate of economic growth
4. Controlling the equitable distribution of income
and wealth

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 Types of Fiscal policy
1. Expansionary fiscal policy
 To overcome unemployment or recession problems
 Increased spending and/or lower taxes
 Budget deficit( government spending in excess of tax
revenues)
 Government uses this policy to shift the aggregate
demand curve rightward in order in order to expand
real output.

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 Types of Fiscal policy
2. Contractionary fiscal policy
 Demand pull inflation occurs
 Lower spending and/or higher taxes
 Budget surplus( tax revenues in excess of
government spendings
 The Government uses this policy to shift the
aggregate demand curve leftward in an effort to halt
demand pull inflation.

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 2. Monetary Policy
 This policy refers to a policy which employs the central
bank’s control of the supply of money as an instrument
for achieving the objectives of the general economic
policy.
 This policy may aim to achieve the optimum level of
employment and output, price stability, balance of
payments equilibrium or other goals of the government ‘s
economic policy with the regulation by the central bank.

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 Objectives of Monetary Policy
 To maintain domestic price stability
 To achieve a balance of payment equilibrium
 To achieve full employment of resources
 To achieve a higher rate of economic growth
 To maintain a continuously low structure of
interest rates.

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 Types of Monetary Policy
1. Contractionary monetary policy
- the government will try to restrict the credit and
reduce the money supply in economy.
- is adopted by the government as a measure to control
inflation.
2. Expansionary monetary policy
- will encourage the availability of credit and make the
money supply increase.
- It is practiced to deal with the problem of deflation
where the level of economic activity is slow.
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 Instruments /tools of Monetary Policy

1. Open market Operation

2. Reserves Ratio
3. Discount Policy ( Bank Rate)
4. Selective Credit Control

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 Tools of Monetary Policy
1. Open market operations
 Buying and selling of government securities (or
bonds)
 Commercial banks and the general public
 Used to influence the money supply

 When the Fed sells securities, commercial

bank reserves are reduced

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 Tools of Monetary Policy
2. The reserve ratio
 The ratio is set by the central bank
 If the government wants to increase the money
supply, it should reduce the ratio and vice versa.

3. The discount rate

 The Fed as lender of last resort
 Short term loans

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 Cont’
4. Selective Credit Control
- The government through the Central bank can
tighten or loosen the provisions of giving loan to
the public.
- If the government intend to reduce the money
supply in fighting the problem of inflation, the
government can make stricter provisions of
giving loan to the public.

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 Expansionary Monetary Policy
CAUSE-EFFECT CHAIN Problem: unemployment and recession
Fed buys bonds, lowers reserve ratio, lowers the
discount rate, or increases reserve auctions
Excess reserves increase
Federal funds rate falls
Money supply rises

Interest rate falls

Investment spending increases
Aggregate demand increases
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 Contractionary Monetary Policy
CAUSE-EFFECT CHAIN Problem: inflation

Fed sells bonds, increases reserve ratio, increases

the discount rate, or decreases reserve auctions
Excess reserves decrease
Federal funds rate rises
Money supply falls

Interest rate rises

Investment spending decreases
Aggregate demand decreases
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 Summary of Government Policies
EXPANSIONARY POLICY CONTRACTIONARY POLICY

MONETARY •Purchase securities and •Sell securities and treasury bills

POLICY treasury bills •Higher legal cash reserves
•Lower legal cash reserves requirement
requirement •Increase bank rate
•Decrease bank rate
FISCAL •Increase government •Decrease government
POLICY expenditure expenditure
Discretionary •Decrease taxes •Increase Taxes

Automatic •Increase transfer payments •Decrease transfer payment

Stabilization •Decrease personal income taxes •Increase personal income taxes

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