Fiscal & Monetary Policy (BBA)

Chapter VI
Fiscal Policy and Monetary

Policy
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Fiscal Policy
Meaning & Concept:

 Fiscal policy is a policy concerning the receipts
and expenditures of the country of government
 It refers to the budgetary policy of the
government.
 It operates through changes in the government
expenditures, taxation and public borrowings.
Contin….
 According to Arthur Smithies, fiscal policy
refers to, “a policy under which the
government uses its expenditure and
revenue programmes to produce desirable
effects and avoid undesirable effects on the
national production and employment”.
Continue…
In short, fiscal policy is the policy which
concerned with the effects of government
expenditure, taxation and public
borrowing on income, production and
employment
Instruments of Fiscal Policy
There are mainly four instruments or
constituents of the fiscal policy;
These are:
(i) budget
(ii) public expenditure
(iii) public revenue and
(iv) public debt.
All these constituents must work together to make
the fiscal policy sound and effective.
Budget
A budget is an estimate of government

expenditures and revenues for a fiscal
year, usually presented to the parliament
by the finance minister
In Nepal, the budget is submitted to the

parliament by the finance minister in the
month of Ashadh, each fiscal year
There are three types of budgetary policies:
Balanced budget policy : When the government keeps its

total expenditure equal to its revenue, as a matter of policy,
it means it has adopted a balanced budget policy.
Deficit budget policy: When the government spends more

than its expected revenue, as a matter of policy, it is
pursuing a deficit budget policy.
Surplus budget policy: When the government follows a

policy of keeping its expenditure substantially below its
current revenue, it is following a surplus budget policy.
Public Expenditure
Public expenditure refers to the expenses made by
public authorities and central and local
governments
Expenditure made on education, health, transport

and communication, public works, etc. are
familiar examples of public expenditure.
In the modern welfare state, the government has to

undertake a number of social and economic
activities for which it has to incur expenditure
Public expenditure can be classified in
three ways:
 Current Expenditure and Capital
Expenditure
 Direct Expenditure and Transfer
Expenditure
 Productive and Unproductive Expenditure
Current Expenditure and Capital
Expenditure
Current Expenditure : The expenditure which

is incurred on civil administration such as
police, parliament, government staff salary,
judiciary etc. They are also referred to as non-
developmental expenditure.
Capital expenditures: Capital expenditures are

intended for the creation of net productive
capacity of the nation
Direct Expenditure and Transfer Expenditure
Direct expenditure: Expenditure incurred on

defence, civil services, educational services,
educational services, judiciary, post office and
investment expenditure etc. are examples of direct
expenditure.
Transfer expenditures: On the other hand, the

expenditures which take the form of payments
made without corresponding return of any factor
services.
Productive and Unproductive Expenditure
Productive expenditures: are those expenditures
which add to the productive capacity or efficiency
of the economy. E.g machinery, facilities as well as
human capital like education, training, health, etc.
Unproductive expenditures: Those expenditures
which do not add to the productive efficiency of the
economy directly. E.g consumption. Expenditure in
administration, defense, justice, maintenance of law
and order are considered unproductive.
However, does not imply that these expenditures are
wasteful and avoidable.
Public Revenue:
The government needs income for

performing a variety of functions. The
income of the government which is
obtained through sources such as taxes,
grants, fees and borrowing, etc are called
public income or public revenue.
Contn..
A fund raised through various taxes is
referred to a tax revenue. A tax is a
compulsory payment. It has to be paid by
the person on whom it is levied.
Tax may be direct or indirect.
According to Dalton, “A direct tax is really
paid by the person on whom it is legally
imposed. The indirect tax is imposed upon
one person but paid partly or wholly by
another.”
Tax may also be classified as proportional,
progressive and regressive.
A regressive tax is one in which the rate of taxation

decreases as the tax payer’s income increases.
A tax is called progressive when the rate of taxation

increases as the tax payer’s income increases
A tax is called proportional when the rate of

taxation remains constant as the income of tax
payers increases
Public Debt
Public debt is the debt which the government
owes to its subject or to the nationals of
other countries
According to Prof. P.E. Taylor, “The debt is
the form of promises by the treasury to pay to
the holders of these promises a principal sum
and in most instances interest on that
principal. Borrowing is restored in order to
provide funds for financing current deficit.”
Internal and External Public Debt
According to Prof. Dalton, “A loan is

internal, if subscribed by persons or
institutions within the area controlled by
the public authority which raises the loan;
external if subscribed by persons or
institutions outside this area.”
Objectives of Fiscal Policy
1. Optimum Allocation of Resources
2. Full Employment
3. Price Stability
4. Equitable Distribution of Income and
Wealth
5. Economic Growth
The objective of fiscal policy in
a developing country
1.Mobilization of Resources
2.Capital Formation
3.Minimize the Inequalities of Income and
Wealth
4.Increase Employment Opportunities
5.Counteract Inflation
6.To Correct Disequilibrium in BOP
Monetary Policy
Monetary policy is basically concerned with

the monetary system of the country.
It refers to the policy measures undertaken

by the Central Bank to influence the money
supply as an investment for achieving the
objectives of general economic policy.
Cont…
Monetary policy helps in the achievement
of such objectives such as optimum level of
output and employment, price stability
and economic growth by influencing the
level of aggregate demand and aggregate
supply and thereby the level of money
income
Cont….
According to A. J. Shapiro, “Monetary
Policy is the exercise of the Central Bank’s
control over the money supply as an
instrument for achieving the objectives of
economic policy”.
Cont….
The Central Bank of a country is the
traditional agent, which formulates and
operates monetary policy in a country
Monetary policy is only a means to an end,

not an end in itself
Instruments of Monetary
Policy
The instruments of monetary policy are of
two types:
1. Quantitative Controls
a. Bank rate policy.
b. Open market operations
c. Changes in cash reserve
ratios.
Cont..
2. Selective Credit Controls
a. Regulation of consumer
credit
b. Regulation of margin
requirements
c. Credit rationing
d. Direct action
e. Moral suasion.
f. Publicity.
Types of Monetary Policy
1.Restrictive Monetary Policy
A monetary policy designed to curtail aggregate
demand is called restrictive (or dear) monetary
policy. It is used to overcome an inflationary gap
The central bank starts a restrictive monetary policy

in order to lower aggregate consumption and
investment by increasing the cost and availability of
bank credit
Cont…
2.Expansionary Monetary Policy
A monetary policy designed to increase aggregate
demand is called expansionary monetary policy
Central bank purchases government securities in

the open market, lowers the reserve requirements
of member banks, lowers the discount rate and
encourages consumer and business credit through
selective credit measures
Objectives of Monetary
Policy
1. Neutrality of Money
2. Exchange Rate Stability and BOP
Equilibrium
3. Price Stability
4. Full Employment
5. Economic Growth with Stability
Monetary Policy in Developing
Countries
1. To Correct Inflationry
Pressures
2. To Correct BOP Disequilibrium
3. Formulation of Effective Interest
Rate Policy
4. To Develop Banking and Financial
System
5. Price Stability
6. Debt Management
The End

Fiscal &amp; Monetary Policy (BBA)

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Chapter VI

Fiscal Policy and Monetary

Meaning & Concept:

A budget is an estimate of government

In Nepal, the budget is submitted to the

Balanced budget policy : When the government keeps its

Deficit budget policy: When the government spends more

Surplus budget policy: When the government follows a

Expenditure made on education, health, transport

In the modern welfare state, the government has to

Current Expenditure : The expenditure which

Capital expenditures: Capital expenditures are

Direct expenditure: Expenditure incurred on

Transfer expenditures: On the other hand, the

The government needs income for

A regressive tax is one in which the rate of taxation

A tax is called progressive when the rate of taxation

A tax is called proportional when the rate of

According to Prof. Dalton, “A loan is

Monetary policy is basically concerned with

It refers to the policy measures undertaken

Monetary policy is only a means to an end,

The central bank starts a restrictive monetary policy

Central bank purchases government securities in

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