HD in Business Management

Module: Business Economics

Lesson: Money Market / Monetary and
Fiscal Policy
 Highlights……
…
• Both Fiscal & Monetary policy can be used to
stabilize the economy
• Effect of Fiscal policy is reduced by crowding
out
• Increased government spending increase
interest rate, reducing and partially offsetting
the initial expansion in aggregate demand
• Liquidity trap the LM curve horizontal etc……

2
Demand and Supply for Money

Ms1 –Ms3 = Surplus

of money

Ms1 –Ms2 =
Shortage of money

3
 Fiscal Policy and AD-AS
Model
• Fiscal policy
– The changes in government spending and taxes
are at the option of the CBeral government.
• Expansionary Fiscal Policy
– Ex: When there is a recession……
• decline in investment spending,
• shift the AD curve to the left
• GDP will fall
• Unemployment will increase
• economyexperienced recession and
cyclical unemployment

4
 Fiscal Policy and AD-AS
Model
• What fiscal policy should do?????
• Increase government spending
• Reduce taxes
• Use combination of above two steps

• Expansionary Fiscal Policy will

create
a
– ( Government government
spending Budget
>
DeficitGovernment Revenues) 5
Expansionary Fiscal Policy
Tax reduction and Increased
Government Spending &
Combination of Both
AS (sec.01)–
than lessthe fully-
employe output
(drecession
) AS (sec.02)
– ofreal
Expansio
n Output
(sec.03)
AS
Economy –reaches
it’s full capacity
of real output

6
Contractionary Fiscal Policy
Tax Increased and reduce
Government Spending &
Combination of Both

7
 Fiscal Policy and Net Export
Effect
Expansionary Fiscal Contractionary Fiscal
Policy Policy
• Problem:Recession • Problem:Inflation
• Expansionary Fiscal • Contactionary Fiscal
Policy Policy
• High Domestic • Low domestic
Interest Rate Interest Rate
• Increase Foreign • Decrease Foreign
Demand for Demand for Currency
Currency • Net Export Increase
• Net Export Decline
8
 Monetary
Policy
• Policy consist of change in Money Supply
to influence interest rates and thus the
total level of spending in the economy

• Tools of Monetary Policy

– Open Market Operations
– Reserve Ratio
– Discount Rate

9
 Open Market
Operations
• Market is “Open” to all buyers and sellers
of corporate and government bonds
(Securities)
• Central bank (CB) buying from and selling
to bonds to the commercial banks and
Public
• This is CB’s most important instrument to
control the money supply and Demand in
the Economy
10
 Reserve
Ratio
• The ratio that central bank ask from
commercial
the banks to deposit at the CB
(money they deposit call Reserves)
• Rising the Reserve ratio
– Bank loose the reserves (shrinking reserves)
– Reduce the ability of the creating money
• Lowering the Reserve Ratio
– Banks gain the reserves
– Ability to create money
• Discount Rate
– Interest rate charge by CB on the loans they granted
to Commercial Banks

11
Thank You