Lecture 4 Fiscal and Monetary Policies PDF

FDNECON (reviewer) Lecture 4 (FISCAL AND MONETARY POLICIES) 1. Goals of Macroeconomics Macroeconomic goals, as seen in prior lectures, aim for: 1. Sustainable Economic Growth 2. Maintaining Price Stability 3. Ensuri...

FDNECON (reviewer) Lecture 4 (FISCAL AND MONETARY POLICIES) 1. Goals of Macroeconomics Macroeconomic goals, as seen in prior lectures, aim for: 1. Sustainable Economic Growth 2. Maintaining Price Stability 3. Ensuring Employment Stability These goals are influenced by three major markets: Goods-and-Services Market (via Fiscal Policy) Financial (Money) Market (via Monetary Policy) Labor Market 2. Overview of Fiscal and Monetary Policies A. Fiscal Policy Instruments used by the government Managed by the Executive Department, approved by the Legislative Department. FDNECON (reviewer) 1  Focuses on government taxation and spending. B. Monetary Policy Governed by the Bangko Sentral ng Pilipinas (BSP). Controls the money supply, which influences interest rates. 3. Fiscal Policy A. Government Expenditure (Government Budget) Fiscal Expansion: Increased government expenditure → Increased income. Fiscal Contraction: Reduced government expenditure → Decreased income. Categories of Government Expenditure 1. Economic Services: Infrastructure, agriculture, tourism. 2. Social Services: Education, health, social security. 3. Defense: National security and peace maintenance. 4. General Public Services: Administration, public order. 5. Debt Burden: Interest payments on debts. B. Taxation Types of Tax Systems: 1. Progressive Tax: Higher income, higher tax rates. 2. Regressive Tax: Higher income, lower tax burden. 3. Proportional Tax: Same tax rate across all incomes. Types of Taxes: FDNECON (reviewer) 2  Direct Tax: Paid directly by the individual (e.g., income tax). Indirect Tax: Paid indirectly through a third party (e.g., VAT). Concepts in Taxation: Equity: Those earning more should contribute more. (earn more, pay more) Efficiency: precise collection. Increase in tax, decrease in income (Fiscal Contraction) Decrease in tax, increase in income (Fiscal Expansion) C. Budget Outcomes Budget Deficit: Expenditures > Taxes Budget Surplus: Expenditures < Taxes Balanced Budget: Expenditures = Taxes Fiscal Policy Effects: Keynesian View: TDLR: Advocates government intervention - Government intervention can have good consequences - “We will all be dead in the long run” - Government can curb consumer spending Classical View: TDLR: Believes in minimal government intervention. - Economy will fix itself in the long run - Government Intervention is unnecessary and will result in negative consequences Crowding Out Effect: FDNECON (reviewer) 3  If the government borrow a lot of money, interest rates would increase (less money available for loans). Increase in interest rates will lead to less borrowing from the private sector, which will weaken the economy and increase government debt. Excessive government borrowing → Increased interest rates → Reduced private borrowing → Potential economic slowdown (weak economy + increased govt debt) 4. Monetary Policy Monetary Policies are used by central banks (e.g BSP) to control the quantity of money, which in turn affects interest rates. A. Role of the Bangko Sentral ng Pilipinas (BSP) Created under R.A. 7653. Ensures price stability for balanced economic growth. Functions: Controls money supply. Manages exchange rates and foreign reserves. Regulates banking systems. Acts as the lender of last resort. B. Instruments of Monetary Policy Primary Tool: Open Market Operations (OMO) Outright purchase/sales of government securities Voluntary transactions with rates set by BSP FDNECON (reviewer) 4  - Treasury Bills (30-360 days) - Bond (3-5 yrs) - Notes (13 yrs) Inflation Rate < Interest Rate Government Securities Transactions: Monetary Expansion: BSP buys securities → Money supply increases. Monetary Contraction: BSP sells securities → Money supply decreases. Secondary Tools: 1. Reserve Requirements: Percentage of deposits banks must hold. Monetary Expansion: Reduced reserve requirements. Monetary Contraction: Increased reserve requirements. 2. Interest Rates: Nominal Interest Rate: Stated rate. Real Interest Rate: Adjusted for inflation. Lower rates → Increased spending (Expansion). Higher rates → Increased saving (Contraction). 3. Exchange Rates: Fixed Exchange Rate: Controlled by the central bank. Floating Exchange Rate: Determined by market supply and demand. 4. Rediscounting: BSP loans to banks using loan papers as collateral. Lower rates → Expansion. Higher rates → Contraction. 5. Printing Money: FDNECON (reviewer) 5  Printing more money expands monetary supply. 6. Moral Suasion: BSP persuades banks to align with monetary goals. 5. Exchange Rate Systems Fixed Exchange Rate: Central bank intervenes to stabilize the currency. (Central Bank sets & maintains the official exchange rate) Floating Exchange Rate: Market-driven and self-correcting. The BSP follows a free-floating system. Lecture 5 (POVERTY, INEQUALITY, AND DEVELOPMENT) 1. Overview Topics: Poverty and Inequality: Focus on the unequal distribution of income and other disparities in developing nations. Dimensions of Inequality: Income and assets. FDNECON (reviewer) 6  Power and status. Gender disparities. Job satisfaction and working conditions. Political participation and freedoms. Education and health. Access to information and technology. 2. Absolute Poverty A. Definition The minimum income level needed to meet basic necessities (food, shelter, clothing). Defined by global and local poverty lines. B. Poverty Lines 1. International Poverty Line: Updated in 2015 to $1.90/day (2011 PPP prices). 2. Local Poverty Line (Philippines): 2018 data: A family of five needed: ₱7,337/month for food needs. ₱10,481/month for food and non-food needs. C. Poverty Incidence 16.1% of Filipino families were below the poverty line in the first semester of 2018. FDNECON (reviewer) 7  3. Measures of Absolute Poverty A. Headcount Index Formula: H/N H: Number of people below the poverty line. N: Total population. Limitations: Does not measure how far below the line the poor are. Ignores income distribution among the poor. Fails distributional sensitivity B. Total Poverty Gap (TPG) Measures the total income required to bring everyone below the poverty line to the threshold. Formula: FDNECON (reviewer) 8  Additional Metrics: C. Human Poverty Index (HPI) Goes beyond income measures: Life expectancy. Education. Economic provisioning. Low HPI = Less deprivation, High HPI = More deprivation. 4. Inequality A. Measuring Inequality 1. Personal Distribution of Income: Focuses on individual income levels. FDNECON (reviewer) 9  Size Distribution of Income: Divide the population into deciles or quintiles. Determine the percentage of income earned by each group. 2. Lorenz Curve: Graphical representation of income inequality. Diagonal line = Perfect equality. Curve deviation = Level of inequality. 3. Gini Coefficient: Quantitative measure derived from the Lorenz Curve. Formula: Scale: 0.00: Perfect equality. 1.00: Perfect inequality. Ranges: 0.20−0.35: Relatively equitable. 0.50−0.70: Highly unequal. B. Factor Share Distribution of Income Examines how national income is distributed among production factors: FDNECON (reviewer) 10  Labor. Land. Capital (financial and physical). Assumptions: Free markets distribute income based on factor contributions. Reality: Non-market forces can distort fair distribution. 5. Key Insights Poverty and inequality are interconnected but distinct issues. Addressing inequality requires analyzing more than income—factors like health, education, and political participation matter. Effective policy-making relies on understanding poverty metrics and inequality measures. Lecture 6 (Education and Health) 1. Overview The central roles of education and health in development and growth. Understanding the relationship between: Education and Development. FDNECON (reviewer) 11  Human Capital Approach. Trends influencing investments in health and education. 2. The Central Roles of Education and Health Health and Education as Development Objectives: Both are critical end goals for improving the quality of life in any society. They serve as indicators of a nation’s development level. Health and Education as Components of Growth: Investments in these sectors have measurable impacts on a country’s productivity and economy. Dual Importance: Education and health are both development goals and growth catalysts. Joint Investments for Development: Health Capital → Increases returns on investments in education. Education Capital → Improves returns on investments in health. 3. Challenges in Improving Health and Education FDNECON (reviewer) 12  Why Increasing Incomes Alone Is Insufficient: 1. Income increases do not always lead to significant investments in children's education and health. 2. Maternal Education: Better-educated mothers raise healthier children. 3. Market Failures: Education and health sectors face significant policy challenges that need government intervention. 4. Education and Development Educational Supply and Demand: Relationship between employment opportunities and the educational demand. Example: If high-skill jobs dominate an economy, there will be increased demand for higher education. Social vs. Private Benefits and Costs: Social Benefits: Society-wide advantages, such as better health and productivity. Private Benefits: Personal gains like higher income and job security. 5. Human Capital Approach Concept: FDNECON (reviewer) 13  Initial investments in health and education lead to higher future income streams. Present Discounted Value (PDV): The current value of future income is compared to the cost of initial investments. Returns: Private Returns: Personal benefits (e.g., higher earnings). Often higher than social returns, incentivizing personal investments. Social Returns: Broader benefits to the community and economy. Key Takeaways Education and health investments are interdependent and essential for sustainable development. Policy Interventions are necessary to address market failures and ensure equitable access. The Human Capital Approach provides a framework to evaluate the long-term value of investing in these sectors. Lesson 7 (History of Economic Thought) NOT DONE!!!!! Important: 1. Memorize the important figures/individuals of economics a. Picture of the person b. The concept attached to the person FDNECON (reviewer) 14  c. What century/year the person comes from d. Names of the book authored 1. Overview Key schools of thought in economics: Mercantilism (1500–1700s). Classical School (1700s–1850s). Neoclassical School (1860s–Present). Keynesian School (1880s–Present). 2. Why Study the History of Economic Thought? 1. Political Economy and Social Science: Understanding economics as a discipline influenced by historical and societal contexts. 2. Cumulative View of evolution: Tracing progressive evolution toward deeper understanding of economic systems. 3. Competitive View: Comparing diverse foundations addressing similar economic realities. 4. Contextual View: Recognizing theories shaped by historical, national, and international backgrounds. FDNECON (reviewer) 15  3. Mercantilism (16th–18th Centuries) Key Features: 1. Emphasis on state wealth accumulation (precious metals, money). 2. Maintaining a positive balance of trade. 3. Heavy state intervention via legislation and protectionist policies. 4. Precious metals, spices, and items - can be sold for a high price due to demand 4. Classical School (1700s–1850s) Emerged during the Industrial Revolution. Notable Economists: Adam Smith: Wrote: The Wealth of Nations (1776). Famous Concept: Invisible Hand FDNECON (reviewer) 16  Known as “father of economics” Criticism of state intervention in economic affairs. (e.g., Believes that the market can correct and adjust on its own without any state intervention.) Markets self-regulate through individuals acting in self-interest. (e.g., the baker is not baking for the art of making bread for the purpose of making a successful business out of it.) David Ricardo: Wrote: On the Principles of Political Economy and Taxation (1817). Famous Concept: Comparative Advantage Trade benefits countries specializing in goods they can produce at lower opportunity costs. Countries gain from trade by trading goods in which they have a comparative advantage (e.g., Ability of a party to produce a good or service at a lower opportunity cost over another country. Countries choose to trade because of comparative advantage.) FDNECON (reviewer) 17  Thomas Robert Malthus: Wrote: An Essay on the Principle of Population (1798). Famous Concept: Malthusian Population Trap: Population growth outpaces food supply, leading to famine and societal checks (war, disease). John Stuart Mill: Wrote: Utilitarianism (1863) FDNECON (reviewer) 18  Famous Concept: Utilitarianism, happiness Doctrine emphasizing actions that maximize happiness or utility. Advocated for limited state intervention to prevent harm. 5. Neoclassical School (1860s–Present) Shift from classical economics with new analytical tools. Notable Economist: Alfred Marshall: Wrote: Principles of Economics (1890) Famous Concepts: Supply and demand, the Marshallian Cross and Marginalism Advocated for: Partial Equilibrium Analysis: Studying individual markets or industries in isolation. Limited state intervention to promote social welfare. FDNECON (reviewer) 19  6. Keynesian School (1880s–Present) Originated during the Great Depression (1929–1939). Notable Economists: 1. John Maynard Keynes: General Theory of Employment, Interest, and Money (1936): Challenged classical assumptions of self-correcting markets. Key Concepts: Aggregate Demand: Drives economic activity; weak demand causes unemployment. Government Intervention: Essential via monetary and fiscal policies to stabilize the economy. Short-Run Focus: FDNECON (reviewer) 20  "In the long run, we are all dead." 1. Alvin Hansen: Known as the American Keynes. Expanded Keynes’ theories to include fiscal policy and business cycles. 1. Hicks and Hansen Synthesis: Developed the IS-LM Model: Describes the interaction between interest rates (monetary policy) and income levels (fiscal policy). Notes: 1. Mercantilism FDNECON (reviewer) 21  a. No specific person attached to Mercantilism b. Dominant thought during the 16th-18th century c. Precious metals, spices, and items - can be sold for a high price due to demand 2. Classical School of thought a. David Ricardo i. British-Jewish descent ii. Involved in the brokerage family 1. Family business is trade 2. The business was regulated by certain laws and so David chose to get into politics for it. iii. Came across the book known as the “Wealth of Nations” by Adam Smith iv. Famous Concept: Comparative Advantage 1. Sample: Ability of a party to produce a good or service at a lower opportunity cost over another country. Countries choose to trade because of comparative advantage. b. Thomas Robert Malthus i. BFF of David Ricardo 1. Was given money by David in order to reduce his debt. ii. Industrial revolution which led to the production of machinery that was able to create more food for the population, which then led to his controversy iii. Famous concept: Malthusian Population Trap 1. Sample: There is going to be a point of crisis when the rate of population is outpacing the rate of resources. c. John Stuart Mill i. Controversial because John got married to a woman after the husband died. ii. Famous concept: Utilitarianism happiness 1. To quantify the happiness of the consumer FDNECON (reviewer) 22  2. The moral worth of an action is solely determined by its contribution to overall utility defined as happiness. 3. Neo-classical School a. Alfred Marshall i. Wrote “Principles of economics” ii. Famous concept: Supply and demand, Marshallian Cross and Marginalism iii. Marshallian Economics 1. Quantity of demand (Qd) a. Factor 1: Price goes up and demand goes down. b. Factor 2: etc etc c. If we analyze the relationship between Qd and Factor 1, then Factor 2 will remain as a constant, vv. 2. Ceteris paribus clause b. John Maynard Keynes i. Known greatly for his explanation for the great depression 1. Occurred during the 1930s 2. Started because of the stock market crash 3. General idea: “No point in living because there is no more savings/money” 4. Prior to 1929: Economists were heavily influenced by the classical school of thought. 5. The general thought: Workers may be able to lower their wages despite the lack of employment because they believe that the market can correct itself. For the lower wage, eventually the GDP will rise once again. 6. Keynes believed that prices are sticky and that the market can not correct on its own. 7. Classical economics believes in the long run and aimed to provide long run solutions ar short run losses, Keynesian economics do not believe in the same thought. FDNECON (reviewer) 23  8. 2008 crisis: Housing investing was considered a safe investment, however the bank’s loaned money to individuals in order for them to pay for the mortgages of houses. a. A lot of banks fell during the 2008 crisis because of the crisis’ domino effect. b. Bush administration chose to save one of those banks i. “Some of the banks are to big to fail” c. If the market was to correct itself, it would have not survived during the crisis. 9. The reason that the United states were able to leave the great depression because of World War 2 a. Pearl Harbor b. Ben Afleck ii. Wrote “General theory of employment, interest, and money” and “Treatise on money”. iii. Macro and micro do not operate on the same basis. 1. Keynesian economics does not believe that price adjustments are possible easily and so the self-correcting market mechanism based on flexible prices also obviously doesn't. 2. “Long run is a misleading guide to current affairs. In the long run, we are all dead.” c. Alvin Hansen i. Known greatly for being the “American Keynes” ii. Famous Concept: Hicks and Hansen Synthesis (IS-LM model), Macro Model 1. IS - Fiscal Policy, LM - Monetary Policy 2. To find the ideal rate and GDP from the model. FDNECON (reviewer) 24