MAWLANA BHASHANI SCIENCE & TECHNOLOGY UNIVERSITY

Assignment
Department of: Business Administration

Assignment No: 02

Name of the Assignment: Details about Monetary and Fiscal Policy

Course Title: Financial Institutions of Bangladesh

Course Code: AIS423

Submitted by Submitted to

Name: Marjukur Rashid Reshma Pervin Lima

ID: BBA17029 Session: 2016-17 Assistant Professor

Year: 4th Semester: 2nd Department of Accounting

Dept of: B.Ad, MBSTU MBSTU, Tangail - 1900

Date of Performance: 11/01/22 Date of Submission: 12/01/22

Monetary policy refers to central bank activities that are directed toward influencing the
quantity of money and credit to control money supply in an economy.

Tools of Monetary Policy

Central banks use various tools to implement monetary policies. The widely utilized policy tools
include:

1. Interest rate adjustment

A central bank can influence interest rates by changing the discount rate. The discount rate is an
interest rate charged by a central bank to banks for short-term loans. For example, if a central
bank increases the discount rate, the cost of borrowing for the banks increases. Subsequently, the
banks will increase the interest rate they charge their customers. Thus, the cost of borrowing in
the economy will increase, and the money supply will decrease.

2. Change reserve requirements

Central banks usually set up the minimum amount of reserves that must be held by a commercial
bank. By changing the required amount, the central bank can influence the money supply in the
economy. If monetary authorities increase the required reserve amount, commercial banks find
less money available to lend to their clients and thus, money supply decreases.

Commercial banks can’t use the reserves to make loans or fund investments into new businesses.
Since it constitutes a lost opportunity for the commercial banks, central banks pay them interest
on the reserves. The interest is known as IOR or IORR (interest on reserves or interest on
required reserves).

3. Open market operations

The central bank can either purchase or sell securities issued by the government to affect the
money supply. For example, central banks can purchase government bonds. As a result, banks
will obtain more money to increase the lending and money supply in the economy.

Expansionary vs. Contractionary Monetary Policy

Depending on its objectives, monetary policies can be expansionary or contractionary.

Expansionary Monetary Policy

This is a monetary policy that aims to increase the money supply in the economy by decreasing
interest rates, purchasing government securities by central banks, and lowering the reserve
requirements for banks. An expansionary policy lowers unemployment and stimulates business
activities and consumer spending. The overall goal of the expansionary monetary policy is to
fuel economic growth. However, it can also possibly lead to higher inflation.

Contractionary Monetary Policy

The goal of a contractionary monetary policy is to decrease the money supply in the economy. It
can be achieved by raising interest rates, selling government bonds, and increasing the reserve
requirements for banks. The contractionary policy is utilized when the government wants to
control inflation levels.

Fiscal policy refers to the government's decisions about taxation and spending. Both monetary
and fiscal policies are used to regulate economic activity over time.

The government has two levers when setting fiscal policy:

1. Change the level and composition of taxation, and/or

2. Change the level of spending in various sectors of the economy.
The two main tools of fiscal policy are taxes and spending. Taxes influence the economy by
determining how much money the government has to spend in certain areas and how much
money individuals should spend. For example, if the government is trying to spur spending
among consumers, it can decrease taxes.

There are three main types of fiscal policy:

1. Neutral: This type of policy is usually undertaken when an economy is in equilibrium. In

this instance, government spending is fully funded by tax revenue, which has a neutral
effect on the level of economic activity.
2. Expansionary: This type of policy is usually undertaken during recessions to increase the
level of economic activity. In this instance, the government spends more money than it
collects in taxes.
3. Contractionary: This type of policy is undertaken to pay down government debt and to
cap inflation. In this case, government spending is lower than tax revenue.
*How fiscal policy affects business?

Businesses directly see the effects of an economy's fiscal policy, whether it's in the form of
spending or taxation. Fiscal policy can have the four following effects on business:

1. Investment opportunities

Businesses can see investment opportunities from government spending as well as private
investment. This commonly happens during an expansionary policy, when more money is
flowing into the economy from the government and from other sources since taxation is also low.
2. Slower growth

A contractionary financial policy may kick in to prevent inflation when that balance is broken
and demand (and prices) falls. Businesses typically rein in their growth due to rising taxes and
take measures to stay in the black with less money flowing through the economy.

3. Taxation changes

Depending on their location, businesses face several levels of taxation, including local, state and
federal. Businesses must contend with how their state and local government taxes them and how
it interweaves with federal fiscal policy.

4. Unemployment rates

A major objective of fiscal policy is to minimize unemployment. For example, the government
can lower taxes to put more money back in consumers' pockets. As such, people may be able to
spend more money, and companies may face increased demand. With increased demand may
come additional production tasks for companies to complete, and businesses can respond by
creating more jobs and hiring more employees. As such, with proper fiscal policy in place, a low
unemployment rate may gradually increase.

• Bangladesh Bank (BB)'s half yearly Monetary Policy Statements (MPS) outline the
monetary policy stance, designed to support government's policies and programs in
pursuit of faster inclusive economic growth and poverty reduction; while also
maintaining price stability.
• In Bangladesh, the fiscal year is 1 July to the next 30 June.
Difference between Monetary and Fiscal policy