Chapter 10 - Macroeconomic Policies PDF
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This document is a chapter from a textbook on principles of economics, focusing on macroeconomic policies. It discusses various concepts related to government roles, types of budgets, and government revenue.
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CHAPTER 10 MACROECONOMIC POLICIES PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 1 GOVERNMENT’S ROLE IN...
CHAPTER 10 MACROECONOMIC POLICIES PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 1 GOVERNMENT’S ROLE IN ECONOMY 1. Adjust the allocation of resources. 2. Assist the private sector to ensure economic stabilization. 3. Create a business environment which encourages competition among producers. 4. Redistribute income and wealth among the population and control income disparity. 5. Provide a legal framework and a social framework for the effective operation of an economy. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 2 TYPES OF BUDGET ❑ A national budget is a document containing a preliminary approval plan of public revenue and expenditure in a year. 1. BALANCED 2. BUDGET 3. BUDGET BUDGET SURPLUS DEFICIT The government’s The government’s The government’s total revenue is total revenue is total revenue is equal to its total more than its total less than its total expenditure. expenditure. expenditure. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 3 GOVERNMENT REVENUE TAX REVENUE NON-TAX REVENUE SOURCES OF REVENUE NON-REVENUE RECEIPTS PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 4 GOVERNMENT REVENUE 1. Tax revenue ❑Tax is a compulsory contribution by an individual or a firm to the government to be used in the common interest of all. ❑Tax is a contribution to the government revenue so that the government can provide the necessary administrative services to govern the country. ❑Direct tax revenue includes individual income tax, companies’ income tax, petroleum income tax, stamp duties, real property gains tax and other income taxes. ❑Indirect tax includes import duties, excise duties, sales tax, service tax, gaming tax, etc. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 5 GOVERNMENT REVENUE 2. Non-tax revenue ❑It is a revenue that arise from other sources besides tax. ❑It includes revenue from licenses and permits, petroleum royalty, interest and returns on investment, fees and penalties. 3. Non-revenue receipts ❑It include refunds of expenditure and receipts from government agencies. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 6 OBJECTIVES OF TAXATION PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 7 OBJECTIVES OF TAXATION 1. Income ❑Taxes are the most important source of income for the government that uses the taxes collected to finance its expenditures. 2. Equitable distribution of income ❑Taxation reduces the inequality of income between the rich and the poor. 3. Reduction of harmful consumption ❑Taxation is imposed on goods such as cigarettes and alcohol in order to restrain people from consuming these and make them expensive. 4. Regulation of foreign trade ❑Taxes are levied on imported goods to protect local industries or infant industries. 5. Conservation of resources ❑Taxes are also imposed on scarce resources such as coal and petroleum so as to increase their prices and discourage exports. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 8 TYPES OF TAXES DIRECT TAXES Tax paid by the person on whom it is levied which cannot be passed on to another person. TYPES OF TAXES INDIRECT TAXES Tax in which burden of tax can be passed on to another person. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 9 TYPES OF TAX STRUCTURE PROPORTIONAL TAX Tax Rate Tax which is imposed at the same rate for all income levels. Income PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 10 TYPES OF TAX STRUCTURE PROGRESSIVE TAX Tax Rate Tax which is imposed at the increasing rate for all income levels. Income PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 11 TYPES OF TAX STRUCTURE REGRESSIVE TAX Tax Rate Tax which is imposed at the decreasing rate for all income levels. Income PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 12 GOVERNMENT EXPENDITURE GOVERNMENT OPERATING EXPENDITURE GOVERNMENT DEVELOPMENT EXPENDITURE General Defense administrati and on Social Economic security services services PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 13 GOVERNMENT EXPENDITURE 1. Government operating expenditure ❑Operating expenditure is the government expenditure allocated to cover the expenses of operating and administrating government departments. ❑It consists of emoluments, pensions and gratuities, debts, service charges, supplies and services, subsidies, asset acquisitions, grants and transfers and other types of expenditure. 2. Government development expenditure ❑Development expenditure is the government expenditure for investment purposes to improve facilities in the basis physical infrastructure. ❑It is focused on development projects that can boost economic growth. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 14 DEFINITION OF MONEY ❑ The term ‘money’ is something that people generally accept as a payment for goods and services. It is also used to pay off debts. ❑ Money is defined as anything that acts as a medium of exchange. FUNCTIONS Medium OF MONEY of exchange Standard of deferred Measure of value Store payment /unit of account of value PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 15 FUNCTIONS OF MONEY 1. Medium of exchange ❑It is any commodity that is generally accepted by people in exchange for goods and services. ❑Money enables us to buy and sell goods and services. ❑The introduction of money as a medium of exchange in the economy removes the inconvenience and inefficiency of the barter system. 2. Store of value ❑Any commodity that can be held in order to enable people to buy and sell it at different times and different places. ❑Money can be held in reserve for future spending. ❑The value can be held over time for as long as the value does not drop. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 16 FUNCTIONS OF MONEY 3. Measure of value of account ❑It serves as a unit of measurement. In Malaysia, the Ringgit is used to measure the value of goods and services. ❑Goods only need to have their prices stated in terms of monetary units. ❑Money as a measures of value provides the basis for keeping accounts, besides calculating profit and loss. 4. Standard of deferred payment ❑A large number of transactions relate to future contractual payments, which are stated in terms of the monetary unit, money. ❑Money make it possible for people to make a contract or an agreement to exchange goods or settle debts in future. ❑However, money is satisfactory only if its value or purchasing power remains stable over time. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 17 Acceptability Durability Portability QUALITIES Divisibility OF MONEY Relative Stability scarcity PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 18 Commodity money Legal tender TYPES Token money OF MONEY Demand Fiat money deposit PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 19 TYPES OF MONEY 1. Commodity money ❑Any item that has its own value and is used as a means of payment. 2. Fiat money ❑Any item that a government orders or declares as money which issued by the central bank of a country. E.g: coins and paper money. 3. Legal tender ❑Paper money that a government approves to be accepted as a means of payment and means of settling debts. 4. Token money ❑Money which has a lower metallic value than its face value. 5. Demand deposits / bank deposits / current accounts ❑Money that is transferable by way of cheques which is generally accepted by the public since the issuing authority is trustworthy. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 20 DEMAND AND SUPPLY OF MONEY DEMAND SUPPLY OF FOR MONEY MONEY Transactions Speculative motive motive Controlled by Central Precautionary Bank motive PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 21 DEMAND FOR MONEY 1. Transaction motive ❑People want to have ready cash to be able to buy goods and services for day-to-day transactions. ❑It depends on the income level of the individual. ❑The higher the level of income, the more transactions can be carried out which leads to a higher demand for this purpose. 2. Precautionary motive ❑Most individuals choose to save some money from their income and keep the rest for unforeseen circumstances such as emergencies, accidents or illnesses. ❑It also depends on the income level of the individual. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 22 DEMAND FOR MONEY 3. Speculative motive ❑Some individuals like to have ready cash with them to take advantage of price changes in stocks or bonds. ❑If the prices of stocks and bonds are expected to fall in the future, speculators would need ready cash to purchase these stocks and bonds. ❑Money demand would lean towards lower interest rates because people would prefer to keep cash than stocks and bonds. ❑This demand for money for speculative motive is inversely related to interest rates. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 23 SUPPLY OF MONEY ❑ Supply of money is controlled by the central bank of a country, which is independent of interest rates. ❑ It depends on the currency issued by the central bank and the policy on credit creation. ❑ The supply curve of money is perfectly inelastic to changes in interest rates. ❑ Basically, every country has its own supply which is used for transactions. ❑ The method used to measure the supply of money are called M1, M2, and M3. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 24 SUPPLY OF MONEY M1: Narrow money ❑M1 is a money used directly in a transaction. ❑Currency(fiat money) – coins and paper money issued by central bank. – Checkable deposits (demand deposits) – checking account balances kept in commercial banks, which are convertible into cash on demand by writing cheques. M1 = Currency + Checkable Deposits PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 25 SUPPLY OF MONEY M2: Near money plus M1 ❑M2 is a broader definition of the supply of money which comprises M1 and near money. ❑Near monies are items that are highly liquid financial assets, which also called as quasi money. – M1 – currency and checkable deposits. – Savings account in commercial banks. – Fixed deposits in commercial banks. – Negotiable certificates of deposits (NCD). – Repo – Central bank certificates. M2 = M1 + Savings and Fixed Deposits in Commercial Banks + NCD + Repo + Central bank certificates. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 26 SUPPLY OF MONEY M3: Broad money ❑M3 is the broadest definition of the supply of money. ❑The difference between M2 and M3 is the savings and fixed deposits in other financial institutions. M3 = M2 + Savings and Fixed Deposits in Other Financial Institutions. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 27 CENTRAL BANK ❑ The central bank is an important financial institution in every country and plays active role in implementing government’s economic policy. FUNCTIONS OF CENTRAL BANK To issue currency and safeguard the external value of the currency Banker and financial adviser to the government Banker to other banks Promoting monetary stability Holder of the country’s stock of gold and foreign currency reserves PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 28 FUNCTIONS OF CENTRAL BANK 1. Issuing currency and keeping reserves ❑Printing of paper currency is one of the central bank’s fundamental functions. ❑BNM is the only financial institution with the authority to issue currency. ❑It helps to safeguard the value of the currency issued. 2. Acting as banker and financial adviser to the government ❑Central banks in all countries act as the banker and financial advisor on all key financial matters to their respective government. ❑In Malaysia,, BNM keeps the government’s principal bank accounts, receives taxes and other revenues, and makes payments in respect of government expenditure. ❑BNM also manages the national debts, sells bonds and redeems matured treasury bills. 3. Acting as holder of country’s stock of gold and foreign currency reserves. ❑Besides managing the country’s foreign exchange reserves, the central bank also implements the government’s exchange rate and balance of payments policy. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 29 FUNCTIONS OF CENTRAL BANK 4. Acting as banker to other banks ❑As the bankers’ bank, the central bank keeps cash reserves of commercial banks in the economy and acts as the custodian of the reserves for the country which supports its credit and banking system. ❑The other banks keep their deposits with the central bank and also act as the lender as a last resort. 5. Promoting monetary stability and a financial structure ❑The central bank is responsible for achieving a high level of employment, maintaining price stability and a reasonable balance with regard to the country’s international payments, eradicating poverty, and restructuring society. ❑The central bank uses quantitative and qualitative measures to ensure monetary stability. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 30 COMMERCIAL BANKS ❑ A commercial bank is an institution that is owned by the private sector and is a profit-making institution. ❑ Banks earn their income from providing banking services such as opening current and savings accounts, providing safe deposit boxes, remittance facilities, paying and collecting on payments by cheque and other such facilities. ❑ A commercial bank earns the most profit from loans and investments. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 31 COMMERCIAL BANKS Functions of Commercial Banks 1. Accepting deposits ❑Bank depend on such deposits from customers in the form of current or demand deposits, savings deposits and fixed deposits. 2. Providing loans and advances ❑Commercial banks give loans such as housing loans, car loans, education loans, business loans, personal loans, and other types of loans to the public and earn profits by imposing an interest. ❑The loans are given in the form of direct loans, overdraft and discounting bills of exchange. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 32 COMMERCIAL BANKS 3. Providing other banking services and facilities ❑Commercial banks also provide other banking services and facilities, including Internet banking, as follows: – Facilitating foreign exchange transactions. – Issuing bank drafts, cheques and traveler’s cheques. – Purchasing or selling stock exchange securities. – Enabling fund transfers from one place to another. – Providing advice on financial matters. – Providing Automated Teller Machines (ATM). – Facilitating bill payments on behalf of customers. – Providing safe deposit boxes for the safe-keeping of valuable items and documents. – Providing credit card facilities, insurance coverage and long-term savings. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 33 GOVERNMENT POLICY MONETARY FISCAL POLICY POLICY PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 34 MONETARY POLICY ❑ It is a policy which employs the central bank’s control of the money supply as an instrument for achieving the objectives of the general economic policy. ❑ It may aim to achieve the optimum level of employment and output, price stability, balance of payment equilibrium or other goals of the government’s economic policy with the regulation by the central bank. ❑ The central bank influences the total amount and the cost of credit primarily by affecting the cash reserves of commercial banks in the economy. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 35 Achieve a balance of payment equilibrium Maintain Achieve full domestic employment price stability of resources OBJECTIVE OF MONETARY POLICY Maintain a continuously Achieve higher low structure rate of of interest rates economic growth PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 36 TYPES OF MONETARY POLICY 1. Expansionary monetary policy ❑It is aimed at increasing the money supply in the economy. ❑It is employed either to control unemployment or during recession. ❑The instruments used in this policy are buying government securities and bonds, decreasing reserve ratio, and decreasing discount rates. 2. Contractionary monetary policy ❑It is adopted to decrease the money supply in the economy. ❑It is employed to control inflation. ❑The instruments used in this policy are selling government bonds, increasing reserve ratio, and increasing discount rates. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 37 FISCAL POLICY ❑ It is a use of government taxation and expenditure influence the country’s spending, employment and price levels. ❑ It is a regulation of the level of government spending, taxation and public debt. ❑ Government expenditure, tax income and public debt are the important factors that influence the aggregate output, employment and prices in the economy. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 38 Securing efficient Attaining and allocation of maintaining full economic resources employment OBJECTIVE OF FISCAL POLICY Controlling the Accelerating equitable distribution the rate of of income and wealth economic growth PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 39 TYPES OF FISCAL POLICY 1. Expansionary fiscal policy ❑It is adopted to overcome unemployment or recession problems. ❑In recession, the economy suffers from rising unemployment, falling income and shrinking economic activity. ❑The government will increase public spending by undertaking public works programmes and reduce taxes. 2. Contractionary fiscal policy ❑It is adopted to overcome inflationary problems. ❑During inflation, the appropriate fiscal policy is to create a budget surplus in order to reduce aggregate spending. ❑The instruments used in contractionary fiscal policies are the increasing of taxes and the reduction of government spending. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 40 INSTRUMENTS OF FISCAL POLICY DISCRETIONARY AUTOMATIC FISCAL POLICY FISCAL POLICY 1. Government expenditure 1. Transfer payments 2. Taxes 2. Taxes PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 41 INSTRUMENTS OF FISCAL POLICY DISCRETIONARY FISCAL POLICY 1. Government expenditure ❑The government will increase its expenditure to control unemployment during recession. ❑During inflation, the government would reduce its expenditure. 2. Taxes ❑The government can increase or decrease the tax rate depending on the circumstances. ❑To control unemployment problems, the government would cut tax rates to increase disposable income and increase taxes during inflation. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 42 INSTRUMENTS OF FISCAL POLICY AUTOMATIC FISCAL POLICY ❑Also called automatic stabilization refers to changes in government expenditure and taxes which occur automatically without any government action. ❑The automatic stabilization would automatically increase aggregate expenditure during a recession and decrease aggregate expenditure when the economy expands. 1. Transfer payments ❑It is the payment of money by a government to individuals for which the payer receives no goods or services directly in return. ❑However, when the economy expands, the government will provide fewer transfer payments. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 43 INSTRUMENTS OF FISCAL POLICY 2. Taxes ❑Personal income tax is structured as a progressive tax in which the higher the income, the higher the tax charged. ❑During recession, many people lose their jobs and some of them are entitled to transfer payments. ❑The government provides more transfer payments during such periods. ❑Some unemployed people may realize lower tax payments or enjoy a tax refund during recession. Both the increased transfer payments and the lower income tax are automatic. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 44 INSTRUMENTS OF FISCAL POLICY ❑ When the economy expands, the unemployment rate would fall and income will increase. ❑ Automatically the stabilizer tools (transfer payments and income tax) will remove spending from the economy to control or reduce inflation. ❑ The government will provide fewer transfer payments and the increase in income results in a higher income tax. PRINCIPLES OF ECONOMICS Third Edition All Rights Reserved © Oxford Fajar Sdn. Bhd. (008974-T), 2013 13– 45