Monetary Authority and the Natural Fiscal Authorities

INTRODUCTION

Fiscal policy refers the setting of the level of government spending and taxation by the government policy makers. It is the combination of taxes and public expenditure to help dampen the swing of the business cycle and contribute to the maintenance of a growing high-employment economy free from high or volatile inflation. In the other words fiscal policy refers a policy which is an important tool for managing the affairs between government income and expenditure. It is the basic management to manage macroeconomics stability and fostering economic growth. At present a number of reform programs are used for stream line public expenditure and revenue management. The government collects large share of revenue from taxation. Public revenue consists of two parts for collection of tax. These are direct tax and indirect tax. From these two types of taxes government earns 80% of total revenue for bearing all kinds of expenditure. Without these taxes government collects revenue other sources i.e. fee, charge, toll etc.

A tax is a compulsory contribution from the person to the government to defray the expense in the common interest of all without reference to special benefits - E.R.A. Seligman. An economic development of a country depends on the level of fan collection. Higher the collection of tax stronger the economy. Public expenditure is another important segment of the fiscal management of the government. Expenditure includes educational expenses, welfare, defense, subsidy etc.

The most significant function of government is the formulation and implementation of a sound fiscal policy. Fiscal policy influences saving investment and growth in the long run. In the short run the primary effect of fiscal policy is on the aggregate demand for goods and services. In the short run the primary effect of fiscal policy is on the aggregate demand for goods and services.

Literature Review

In order to analyze the game between the monetary authority and the natural fiscal authorities in monetary union the starting point is considering macroeconomic policy as conducted through two instruments, monetary and fiscal policy. It is generally accepted that the economic decisions made in one country can have significant spillover effect on other economics (Frankel and Rockett, 1986). This led to significant pressure for government to coordinate their economic policy.

The issues of policy coordination between one country and other countries that cooperate across them have had a central place in the literature on the design of macroeconomic policies in the EMU. This is no surprising given that EMU is to a certain extent an “experimental laboratory”? representing a very interesting case study. Some of the literature review about fiscal policy has been given in the below:

“Fiscal policy we mean the se thing of taxes and public expenditures to help dampen the swings of the business cycle and contribute to the maintenance of a growing, high employment economy free from high or volatile inflation Keynesian approach believed that fiscal policy was like knob they could turn to control or “Fine-tune”? the pace of the economy.

A bigger budget deficit meant more stimulus for aggregate demand, which could lower unemployment an pull the economy out of recession. A budget surplus could slow down an overheated economy and dampen the threat of inflation”?. (Samuelson, P.A. and Nordhus, W.D., 2006).

Beetsma and Bovenberg (1998) focus their attention on the interaction between monetary fiscal policies in monetary union. They found that monetary union with decentralized fiscal policies and centralized monetary policy produces an inflationary bias and excessive spending on public goods. The main policy making suggestion deduced from their study is that fiscal coordination or fiscal centralization may discipline the macroeconomics policy in the EMU member countries. The practical response to these studies calling for tighter coordination between monetary and fiscal policies at the European level was the creation of the SGP (Stability and Growth Pact) that limited the maneuver area for fiscal authorities in their expansionary fiscal policy driven by the government deficit (Bini Smaghi and Casini, 2000). Another important thing for fiscal policy is that “The fiscal policy took the driver’s scat in the policy formulation of the governments so as to achieve their objectives. In modern day economics fiscal policy is quite ahead of monetary policy and other policies as an instrument in the hands of the governments to achieve their desired economic and non-economic results”?. (K.K. Dewett, 2005).

In the case of a cooperative game only among the fiscal policies of the EMU member countries, in which the ECB stays outside the fear of inflationary pressure due to an excessive expansionary fiscal policy will determine very small welfare gains. Their policy implication of straightforward; the SGP might have a very strong limiting impact on the efforts for a positive or active cooperation in EMU which would lead to more output and employment but will deal with interest rates and exchanges rate disturbances, which alter the equilibrium in investment and saving in EMU (Eichengreen and von Hagen, 1996).

Cooper and Kempf (2000) analyze monetary and fiscal policy interactions in a two country model, with and without a monetary union, where the monetary and fiscal authorities agree on the macroeconomic goals. When the monetary authority has leadership, a monetary union is pareto-efficient. However, if the fiscal authorities have leadership, a monetary union is Pareto efficient only if the aggregate shocks are highly correlated. The variables of monetary and fiscal policies using ordinary least square (OLS) technique and found out that monetary influences are much larger and more predictable than fiscal influences. This result was confirmed with the use of beta coefficients that changes in monetary action were greater than that of fiscal action. In essence, greater reliance should be placed on monetary actions (Ajayi, 1974).

Elliot (1975) examined the relative importance of money supply changes compared to government expenditure changes in explaining fluctuations in nominal GNP. He was of the opinion that this area of study had continuing capacity to provide debate among economists. He estimated St. Louis equation with the use of OLS technique. The equation is of the form.

where aˆ+Y represents the change in nominal GNP, aˆ+M represents the change in money supply while aˆ+E represents the change in high employment federal government expenditures.

Tabellini (1986), analyzed the coordination between a single monetary authority and several independent fiscal authorities in the context of a game model, shows that policy coordination between the fiscal authorities and the common monetary authority increases the speed of convergence toward the common steady state as compared to the outcome of the non-cooperative game.

We reviewed previous researches focusing on the actual situation in EMU, where countries have common currency and separate fiscal authorities that run independent fiscal policies. In this paper we searched to interpret the implication of monetary and fiscal authorities arisen from the well known and widely accepted research published in last decades. In fact from our literature review of resulted that, independently from the type of shocks, coordination between fiscal national authorities is associated with larger governmental and social benefits if above mentioned requirements for the policy coordination are met.

Topic analysis

Fiscal policy is a policy which is an important tool for managing the affairs between government income and expenditure. Fiscal policy uses for maintaining balance between public income and expenditure. It tends to expand the economy in the short run that is under conditions on of less than full employment. Higher spending and lower taxes tend to increase aggregate demand, output employment and inflation. Because of the financial reaction of interest rates and exchange rates the expansionary impact is reduced and may eventually disappear. Fiscal policy is the combination of taxes and public expenditure. Revenue consists (tax) of two parts. Such as:

Tax revenue

Non-tax revenue

Tax revenue included direct tax and indirect tax. Non tax revenue included administrative revenue, commercial revenue, grants and fits revenue.

The revenue is shown by a figure:

Government Revenue

Tax Revenue

Non tax Revenue

Direct tax

Indirect tax

Administrative

Revenue

Commercial

Revenue

Grants and Gifts

Expenditure is another important segment of the fiscal management of the government. Expenditure includes educational expenses, welfare defense, subsidy, health and population control finance collection department etc. Most expenditure sector for government of defense. It the government approaches a sound fiscal policy a country can develop with rapidly.

Government use budgets to plan and control their fiscal affairs. A budget represents for a given year, the planned expenditures of government programs and the expected revenues from tax system. The budget typically contains list of special programs (education, welfare, defense as well as tax sources.

Budgets are of three kinds. These are :

Surplus budget : A budget surplus occurs when all taxes and other revenues exceed government expenditures for a year.

Deficit budget: A budget deficit incurred when expenditures exceed government taxes.

Balanced budget: When revenues and expenditures are equal during a given period is called balance budget.

The government budget serves major economic functions its is a device by which the government can set national priorities, allocating national output among private and public consumption and investment and providing incentives to increase or reduce output in particular sectors. From a macroeconomic point of view it is through fiscal policy that the budget affects the key macroeconomic goals. We will review the major ways in which government can employ fiscal policy and we will examine the practical shortcomings that have become apparent by actual, structural and cyclical budgets.

The actual budget records the actual dollar expenditures, revenues and deficits in a given period.

The structural budget includes what government revenues expenditures and deficits would be if the economy were operating at potential output.

The cyclical budget is the difference between the actual budget and the structural budget. It measures the impact of the business cycle on the budget taking into account the effect of the cycle on revenues expenditures and the deficit.

Objectives of fiscal policy

The followings are the main objectives of fiscal policy

Economic growth

Full employment

Price stability and

Social justice

Economic growth:

Economic growth is nothing but an increase in the economic activities or economic variables over a period of time.

Full employment:

This helps the economy to move up and increases the economy.

Price stability:

It helps to make price stable.

Social justice:

The government can achieve social justice by imposing higher rate progressive taxation on the rice and giving subsidies and concession to the lower income and middle income groups.

Fiscal policy work:

Government directly and indirectly influence the way resources are used in the economy. The basic equation of national income accounting helps show now this happens:

GDP = C+I+G+NX

Here, GDP refers gross domestic product the value of all final goods and services produced in the economy. Right side shown consumption (c), (I) investment, (G) Government purchase, and (NX) Net export.

This equation makes it evident that government affect economic activity (GDP), controlling ‘G’ directly and influencing C.I. and NX indirectly, through changes in taxes, transfers and spending.

Fiscal policy that increases aggregate demand directly through an increase in government spending is typically called expansionary or “loose”?. By contrast fiscal policy is often considered concretionary or “tight”? if it reduces demand via lower spending.

How Fiscal policy influences aggregate Demand:

The government can influence the behavior of the economy not only with monitory policy but also with fiscal policy. Fiscal policy refers to the governments choices regarding the overall level of government purchase or taxes.

Changes in Government purchase:

Policy makes can influence aggregate demand with fiscal policy. An increase in government purchases or a cut in taxes shifts the aggregate demand curve to the right. A decrease in government purchases or on increase in taxes shits the aggregate demand curve to the left.

The multiplier effect:

Multiplier effect the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and there by increases consumer spending.

Multiplier = 1+MPC+MPC2+MPC3+

MPC=Marginal prosperity to consume

This multiplier tells us the demand for goods and services that each dollar of government purchases generates. To simplify this equation for the multiplier recall from math class that this expression is an indefinite geometric series. For between-1 and +V1

1+X+X2+X3 + ............ 1/(1-X)

In our case, X = MPC, Thus

Multiplier = 1 (1-MPC)

The crowding out effect:

Crowding out effect the effect in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending the effect of the increase in money demand is shown in panel (a) of + Because the fed has not changed the money supply, the vertical supply curve remains the same. When the higher level of income shits the money demand curve to the right from MD to MD2, the interest must rice from r1 to r2 keep supply and demand in Balance. This crowding out effect partially affects the impact of government purchases on aggregate demand, as illustrated in panel (b). The increase in government purchase initially shifts the aggregate demand curve from AD1 to AD2 but once crowding out takes place, the aggregate demand curve drop back to AD3.

How fiscal policy might affect aggregate supply : Most economists believe that the short run macro economic affects of fiscal policy work primarily through aggregate demand. Fiscal policy can potentially also influence the quantity of goods and services supplied For instant consider the affects of tax changes on aggregate supply. One of the ten principles of economics that people respond to incentives. When government policy makers cut tax rates, workers get to keep more of each dollar they earn. So, they have a greater incentive to work and produce goods and services. If they respond to this incentive the quantity of goods and services supplied will be greater at each price level and the aggregate supply curve will shift to the right.

Some economists called supply sides have argued, that the influence of tax cuts on aggregate supply is large. According to some supply-siders, the influence is so large that a cut in tax rates will stimulate enough additional production and income that tax revenue will actually increase. While the supply-sides affects of taxes are important to consider. They are usually not large enough to cause tax revenue to rise when tax rates fall.

Economic development in Bangladesh: economic development is one of the most inclusive concept of development Economic development includes to the raising of the productive capacity of a country through the introduction of policies designed to enhance the productivity of land, labor and capital raise standards of living and alleviate the poverty of the inhabitants of a country. At a minimum , economics development has a growth and a distributive dimension.

Since 1990 Bangladesh has seen major improvements including some development indicates such as: rates of economic growth, poverty, education, population, regulation, infant morality, and literacy. Bangladesh has been less successful manage wealth and income, inequlaties, infrastructure problems, energy supplies, and the broader management of economic development. Bangladesh could become a middle income country by 2016 it refers in a recently released up beat report (2007) to make middle income country it needs to deepen its industrial base, become more integrated into global markets and priorities urban economic development as a key driver of growth.

1975-2006 per capital GDP has more than doubled with a per capital GDP growth rate of 3.3% par-annum.

1992-2005 poverty rate declined from 58 to 40 percent.

Since 1974 Bangladesh achieve food self sufficiency in rice but productivity remains low. Those most affected are the poor and landless people because their have no ability to buy.

1990s and 2000s real agricultural wage rates increased but the national information sector incomes has been decline (50% of total work force).

1990 to 2006 merchandise exports ratio increased to 6%-18%. At present garments, textiles, pharmaceuticals, food and leather are contributed 16% to national GDP up from 5% in the 1980s.

At present Bangladesh has existed with energy supply inadequate, infrastructure problem and soon. Besides these problems Bangladesh develops her economy day by day. Dhaka will move up the mega-city scale to become one of the world’s largest cities by the 2020s. Urbanization is rapid and expected to reach 60% of the population by 2050. Since independence in 1971 Bangladesh try to develop her economic growth and she successes most of the sector. Many ways are followed by the government for economic growth. All of them a sound fiscal policy is the most important way for develop a country. Because of fiscal policy influence the national saving, investment, aggregate demand and supply. And saving investment, demand, supply are the main indicator to develop a country. So, rapidly a country develop are depended on a sound fiscal policy.

Findings

Fiscal policy is an important tool for managing the affairs relating government income and expenditure fiscal policy uses by the government for balancing between buldie income and expenditure. Fiscal policy can be defined as the conscious policy of a government so as achieve certain predetermined socio-economic objectives with the help of public revenue, public expenditure. It can also be defined as the policy of the state, so as to achieve certain desired economic and non-economic objectives, and avoid undesired effects, with the help of public revenue, public expenditure. Mrs ursulatticks, says, fiscal policy is concerned with the manner in which the different elements of public finance, while still primarily concerned with carrying out their own deficits may collectively be geared to forward the aim off economic policy public revenue consists of two parts. These are direct tax and indirect tax. From these two parts a large share of revenue is earned. For bearing the government expenditure, Government expenditure includes educational expenses, welfare, defense, subsidy, health and population control, finance collection department, fiscal policy is controled by budget. Budget consists of surplus, deficit and balanced budget.

In order to achieve long-term goals, Bangladesh needs to address the following:

eliminate the budget deficit and free itself from its dependence on foreign aid;

boast and diversity agricultural productivity in order to achieve food self-sufficiency;

implement measures to further alleviate poverty and control the country’s high population growth,

Promote private investment,

promote the privatization of state owned enterprises, liberalize trade, institute financial reforms and other structural adjustment, measures, and cultivate export-oriented industries, and

-maximize administrative efficiency and simplify procedures.

Public expenditure promotes economic development in the following way-

Social and economic over heads: Economic development is handicapped in under developed country on account of the lack of the necessary infrastructure. Economic overheads like the roads and railways, irrigation and power projects are essential for speeding up economic development. Social overheads like hospitals, schools and colleges and technical institutions too are essential. Money for these things can not come out of private sources. Public expenditure has to buildup the economic and social overhead.

Balanced Regional Growth

It is considered desirable to bring about a balanced regional growth. This requires huge amounts for which reliance has to be placed on public expenditure.

Development of Agriculture and Industry

Government to incur lot of expenditure in the agricultural sector, e.g. on irrigation and power, seed forms, fertilizer factories, warehouses, etc. and in the industrial sector by setting up public enterprises like the steel plants, heavy electrics, heavy engineering, machine making factories etc. All these enterprises are calculated to promote economic development.

Subsidies and Grants

The central government gives grants to state government and the state government to local authorities to induce them to incur some desirable expenditure. Subsidies have also to be given to encourage the production of certain goods especially for export to earn much needed foreign exchange. The nations savings and investment balance is primarily affected by the structural budget. Effects to change government saving should focus on the structural budget because no durable change comes simply from increased taxes due to an economic boom.

Policy Recommendation

The discussion about the fiscal policy and management that has been occured in the previous pages involve some limitations. Owing to immobility of labour, the policy may fail in creating additional employment. Road Making, for example, cannot absorb the unemployed textil works.

Besides, in a democratic state, the public may bitterly oppose heavily surplus budgets during period of prosperity and may demand tax reduction.

Sufficient care well also have to be taken to ensure that the spending by the state is in such spheres only which would not have been taken up by private investors, otherwise public investment does nothing more than merely replace private investment. Moreover, public spending should not increase the difficulties of private by raining the cast of construction materials, building labour etc.

So, every government most maintain some recommended policy that has been give in the below:

-Raise enough revenue to finance essential expenditure without recourse to excessive public sector borrowing.

-Raise the revenue in wise that might be equitable and could minimize its disincentive effects on economic activities.

-Do, so in ways that do not deviate substantially from international norms.

- Changing public expenditure on public works and other government purchases.

- Changes in government contribution to the income stream trough transfer payments that is employment benefits etc.

- An appropriate international economy policy.

Every government must maintain a sustainable fiscal policy, which includes a deficit that is manageable in the short term and the associated public debt is creats being serviceable. The case studies show that sound fiscal policy, involves much more than this. The economic function of government is not merely to maintain a stable macro environment, its primary responsibility to its citizens is to foster the general welfare. A deficit target should not be set that undermines a government’s ability to achieve the letter. Government should encourage expenditure in productive sector and exercise austerity in public expenditure and restrain oven unproductive outlays.

Conclusion

Every country need fiscal policy for their economic development. The two wings of fiscal policy are government revenues and government expenditure. The governments fiscal policy can contribute to the control of inflation either by reducing private spending by increasing the taxes of on private sector or by decreasing government expenditure or combining both the elements. Automatic fiscal stabilizes help moderate economic fluctuation. The contribution discretionary fiscal policy can make in combating economic recession in more debatable. Fiscal policy is also called the control cyclical management of public finance may be operated both through public revenues and public expenditure. Between these two, the expenditure method is far more effective in stimulating business activity. Moreover the revenue method leaves the entire initiative to the business community and is also not capable of directing expenditure into changed which may be particularly desired however best results will be achieved if both of them are combined. Fiscal policy influence the national saving, investment, aggregate demand and supply. Saving investment, demand, supply are the main indicator to develop a country. So, rapidly a country develop are depended on a sound fiscal policy.

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