Aims Of The Government:
Equality for all: everyone should have equal distribution of income and equal contribution to GDP
Poverty: Raise funding and utilize it for the betterment of people living below the poverty line and are unemployed due to immobility/unskilled/low productivity, the funds are spent on education, healthcare and sanitation
Stable Prices: Policies are used to keep the value of money stable so there is no depletion of value which causes value of currency to fall hence exchange rate falls with power of exchange causing imports to become expensive and value of exports to fall causing a trade deficit.
Full Employment: No unskilled or skilled worker should be made redundant not be employed again hence the government may provide tax exemptions by employing workers so overall standards of living rise.
Trade Surplus Without Affecting Domestic Industries: Government wants an active market of imports and exports hence it may encourage free trade at first for better foreign relations and alliances but it may imply some protectionist policies to ensure the domestic market isn’t being competed with imports hence it may imply quotas, tariffs and embargoes to an extent and subsidize good domestic performers decrease prices of domestic goods and raise prices of imported goods
Stable Forex Rates & Reserves: A government may want an appreciated/revalued forex rate since the value of the currency rises in comparison to other currencies causing cheaper imports and higher value exports so trade deficit may decrease and it may even cause trade surplus in the long run. It may also a high demand of its currency causing value of currency to rise and also a rise in supply of other foreign reserves which are gained by exchanging a powerful currency and when inflation may hit and value of the powerful currency decreases, the value of currency may be matched by selling foreign reserves to raise supply of the other currency and decrease the price causing stabilization of foreign currencies.
Policies:
Fiscal: Fiscal Policy refers to the expenditure and the income of the government. It decides how the money should be spent and on whom. It also focuses on how to increase the income of the government by direct or indirect taxation.
Direct Taxation – Imposed directly on any sort of money earned by the consumer which is used for providing merit/public goods and raising standards of poor people. EG: Income tax, Inheritance tax, Corporate tax and Capital-Gains tax.
Indirect Taxation: Implied indirectly on the goods and services consumed by the consumer or producer and used to build infrastructure and payment of government employees. EG: Tariffs, Import Duty, Sales tax, Custom Duty
The money gathered by payment of these taxes add up to the government’s income which is segregated and proportions are decided on how to spend the money gathered. The government may spend more than it earns most of the time. That’s why the government is in a budget deficit and it raises money by controlling the taxes and expenditure (magnitude and sectors).
It may imply either contractionary or expansionary fiscal policy.
Contractionary policy is when income of the government is increased by raising direct and indirect taxes and expenditure is decreased on unnecessary areas which are not profitable.
Expansionary policy is when expenditure is increased and the economy needs an economic boost and money needs to be supplied in the market hence magnitude of expenditure is increased and the tax is decreased to raise the disposable incomes of consumers.
When is contractionary policy or expansionary policy used?
Contractionary policy is used when there is enough supply of money and liquidity in the market and it is causing the value of money to fall, hence the government stops spending on “unnecessary” sectors and raises taxes in order to stabilize the spending and repay all the debt. In short it is used for stabilizing the economy and withdrawing all the excess cash flow to stop inflation and increase the income of the government by levying more taxes like excise duty.
Expansionary policy is used when the economy has less cash flow and unemployment with low standards of living and low GDP with bad infrastructure and less labor mobility. The government takes debts from international or regional banks and uses them in building of infrastructure, reforming labor markets and subsidizing firms with provision of merit and public goods and decreases tax rates so disposable income rises causing spending to rise and hence standards of living rise with external economies of scale gained by good infrastructure and retrained productive labor.
Monetary: Monetary policy is used to control the supply of cash in the market to control inflation and deflation while also controlling forex rates and reserves. Monetary policy uses interest rates to control supply of cash in the market.
How is the supply of cash controlled?
The rate of interest in commercial banks is proportional to the rate at which money is lent to commercial banks by the central banks hence money supply can be regulated by changing the rate of interest of money lent to commercial banks. The liquidity in commercial banks is unchanged since the rate of interest to banks is passed on to the rate of interest to consumers.
Contractionary policy: The interest rates to the bank are increased leading to increase in interest rates for consumers and supply of cash is decreased in order to decrease supply of money in market leading to less spending since saving is higher returns
Expansionary Policy: The interest rates are lowered to the bank causing interest rates tof all for the consumers and supply of cash to rise leading to more spending by the consumers since savings has lower returns.
When is expansionary and contractionary policy used?
Expansionary policy is used when the economy has low supply of money and lower standards of living and banks have low liquidity due to lending to maintain standards of living hence the central banks decreases the interest rates and so does the bank hence the supply of money rises hence borrowing rises since savings will lead to lower returns causing more expenditure by the consumers hence standards of living rise and employment rises too since firms are willing to borrow and expand yet leads to inflation since rise in supply leads to fall in value
Contractionary policy is used when the economy has a high supply of money in the market and consumers have been spending too much which is leading to fall in value of money in domestic and international market hence the central bank increases the interest rates which causes more profitability in saving rather than spending and the supply of money is withdrawn leading to rise in value of money and decrease in rate of inflation
Supply Side: Supply side policy is used to organise the unorganised labour market by training, reforming, retiring and subsidising in order to increase the employment rate and increase the efficiency by replacing old workers by new and productive ones. The government uses subsidising and retraining in order to increase average production capacity of the economy.
How is supply side policy implied: The supply side policy is implied by expenditure in the labour market which is unorganised due to unequal payment and trade unions hence the government may decide to build institutions to increase the quantity of skilled labour and increase the average pay of workers to increase government revenue with standards of living. It may also retrain workers and provide retirement benefit to old and unproductive workers in order to increase the productive potential and quantity/quality of labour in the economy.
What can be done to reform the labour market?
- Build institutions to increase quantity of skilled labour
- Pass legislations in support with trade unions to decrease unemployment
- Pass through a national minimum wage for unskilled labour
- Tax firms which have a rate of layoffs
- Subsidise new firms which are doing fresh hirings to raise employment
- Provide retirement pensions to workers who have become unproductive
- Imply expansionary fiscal and monetary policy to raise money supply
- Stop emigration by providing state benefits and subsidies
- Build infrastructure to increase external economies of scale
Emigration : Labours leaving the country
Immigration: Labours coming to the country
National Minimum Wage: National minimum wage is implied when unskilled workers are paid less than their expenses since they do basic jobs and with inflation the survival becomes difficult since prices rise yet their wage may decrease due to unequal distribution of money hence the government may set a basic wage which the firms need to pay for the labour to increase their standards of living and afford basic necessities. The wage needs to be higher than the NMW otherwise actions may be taken against firms
Inflation:
Inflation is the phase in an economy where the prices are rising and the value of money is falling due to increase in supply of cash in the market which leads to fall in power of the currency in domestic and foreign markets.
Is inflation harmful or useful for an economy?
Inflation is when supply of money in an economy rises and average consumer spending rises due to increase in expansionary policies by the government in order to deflate value of money and inflate prices since aggregate demand rises Which leads to decrease in value of currency domestically and internationally causing devaluation/depreciation in currency causing forex rates to decrease and imports to become expensive with the savers to lose money since returns are on fixed interest rates hence the value of money returned before inflation must be higher than the same amount with inflation causing value of assets to fall and average wealth to decrease.Furthermore, since power of currency falls in international markets, the central bank sells foreign reserves in order to stabilise the forex rate by increasing supply of other currencies; which results in internation conflicts as well as lack of foreign currencies to pay for imports.
Landowners, banks, lenders,savers , import distributors and exports all suffer due to inflation
Borrowers are the only ones who benefit since they have to pay less than the actual value of the repayment
