MONETARY AND FISCAL

POLICIES
Economic Policies
Learning Objectives
What is Economic Policy?
What is Economic Policy?
• It is based on economic theory or principle.
• It is the application of a theory or principle.
• Economic policies are formulated to attain specific objectives or
solve certain problems.
What is Economic theory?
What is Economic theory?
• Is derived from facts.
• Data are gathered and presented for analysis.
What is a Good Economic Policy?
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It must be stated in broad terms.
It must be long range, but flexible to a certain degree.
It must be in writing and easy to understand.
It must be widely acceptable.
It must be reasonable.
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It must be consistent with the objectives and goal to be attained.
• It must be communicated to all concerned.
• It must be implementable.
• It must cover all important relevant aspects.
• It must be in accordance with the law.

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Nevertheless, the most important element of a good
economic policy is its deep concern for the welfare of
the people, especially the poorest of the poor.

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Precisely, it is this group – which is the largest group
in the less developed countries – that needs most the
benefits of a good policy.

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People-oriented policy
• The welfare of the people is always the primary consideration.
• Even the business corporations of Japan fashion their policies
towards human resource development.
• To them their employees are the most important assets.
 Dr. Placido Mapa, Jr., former Minister of
Economic Planning said:
Man has always been the focus of all development efforts, hence,
the ultimate goal of all development activities is to improve the
people’s quality of life. This brings us to a point: that of sharing the
fruits of development. And this goal can only be achieved by
pursuing national development policies for various regions, through
which the government hopes to redress income disparities caused by
growth imbalances.
Objectives of Economic
Policies
• Economic Growth
• Full employment
• Economic Freedom
• Equitable distribution of wealth and income
• Economic security
• Economic stability
Monetary Policy
• Professor James Boughton defined monetary policy as the process
whereby the monetary authority attempts to achieve a desired set
of economic goals by controlling either the money supply, the
cost and availability of credit or the allocation of credit to its
various uses.
Monetary Board
• Is the Monetary policy-making body of the government, headed
by the Central Bank governor.

The Bangko Sentral ng Pilipinas

• Is responsible for implementing the monetary policies
formulated by the members of the monetary board.
The Primary Monetary Goals of The Bangko Sentral ng Pilipinas

1. To maintain internal and external monetary

stability in the Philippines and to preserve the
international value of the peso and its
convertibility into other freely convertible
currencies; and

2. To foster monetary, credit and exchange conditions

favorable to a balanced and sustainable growth of
the economy.
Major Monetary Tools

• Legal reserve requirements - increase or decrease of the

percentage of reserve deposits of banks as required by the
Central Bank.
• Open-market operations – purchases and sales of
government securities by the Central Bank.
• Moral suasion – appeal of the Central Bank to the banks to
expand or contract their credit or to suspend types of bank
credit.
Ideas on Monetary Policy

• The Keynesians, led by Samuelson, Tobin, and Heller, believe that a free
enterprise economy has several inherent limitations. For example, It does not
provide social goods, it does not properly allocate resources, and it leads to the
unfair distribution of income.
• The followers of John Meynard Keynes consider the active role of government
in stabilizing economic activities. They believe fiscal tools are better than
monetary tools in achieving economic stability, resource allocation, and income
distribution.
Ideas on Monetary Policy

• Professor Paul Wonnacott of the University of

Maryland stated that Keynesian economics
underestimates the role of monetary policy in
stimulating aggregate demand and that the
Keynesian theory stresses the instability of
private markets.
Free Market System is better

• The monetarists, headed by Milton Friedman challenged the Keynesian

concepts. They believe a free enterprise economy or laissez faire is better for
the whole economy.
• Economists under Adam Smith also stressed that free competition
automatically distributes resources efficiently. Through free market
mechanism, goods and services are better allocated than through government
agencies or interference in the market system.
• Monetarists claim that the government decision- making process is
bureaucratic, inefficient, and harmful to individual incentives. The centralized
decisions of the government destroy individual freedoms.
₱₱ Role of Money Supply
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Keynesian economists believe that monetary policy has an indirect effect on
national income by causing changes in the interest rate which in turn changes
consumption and investments.
- They believe that monetary policy can successfully keep the economy on
steady growth with low unemployment only when it is combined with
appropriate fiscal policies.
Monetarists argue that changes in the money supply have direct effects on the
national income.
- They claim that stable prices and a steady growth rate of real GNP can only
be achieved by allowing the money supply to increase at approximately the
anticipated real growth rate of the GNP.

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Shortcomings of Monetary Policy

• When a monetary or financial problem or need₱₱

emerges, monetary authorities have to confirm it
by gathering facts. These have to be presented and

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analyzed in order to be able to formulate sound
and appropriate monetary policies. The whole
process takes time, and even longer for the less
developed countries.

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Shortcomings of Monetary Policy
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• The impact lag which is the time between the
implementation of the monetary policy and
the time the effects of the policy becomes
evident on the various sectors of the

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economy.

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₱₱ Shortcomings of Monetary Policy

• A monetary policy is very weak during deep

depression. Even if banks offer the lowest
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possible interest rate to investors, still there
are no takers because the expected returns of
investment are even lower than the interest
rate.

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 Other Limitations

• In less developed countries, their money markets and credit institutions

are unorganized and fragmented. This makes the administration of
monetary policies less effective.
• Many commercial banks in developing countries are branches of big
banking institutions in highly developed countries like the United States.
Naturally, such branches of foreign banks are more interested in the
monetary policies of their own countries than the local policies.
• The ability of the Third World governments is further limited by their
dependence on foreign exchange earnings like dollars.
 Other Limitations

• Todaro gave his negative impressions on the dual monetary system

of most less developed countries. That is one for the rich and
another for the poor. However the system tends to serve more the
needs of the wealthy groups who are considered safe borrowers.
Universal Banking

The Philippines has adopted the concept of expanded

commercial banking which is a variation of the German model
of universal banking.

It has been observed that heavy reliance on short- term finance

created a climate of uncertainty for investors and reduced capital
formation.

Furthermore, the present financial system favored misallocation

of existing financial intermediation.
Fiscal Policy
• Is another major economic policy.
• Refers to the revenue and expenditure measures of the public
budget.
• Fiscal policy-making involves the voters, the president and his
cabinet, and the legislative body.
• As stated earlier, the monetarists and the classical economists
believe that the free market system is the best way to allocate the
resources of the society. Such idea is not completely correct. There
are market imperfections such as the inadequate market
knowledge of both sellers and buyers, obstacles to free entry in
the market, and the unfair business practices.

• Overpricing, adulterated products, tampered weights and

measurements, etc.
Provision of Social Goods
• There is one area in which the free market mechanism hesitates to engage
in. This is the provision of social goods like anti-pollution projects, roads
and bridges that are not heavily used and other social infrastructures which
do not yield good profits.
• Social goods generally incur huge investment of funds, and yet many of
them are not profitable. For instance, constructing a long road in a
mountain village is not a sound business project.
• Since the government is for service and not for profit, it can
construct roads, bridges, and other projects like
communication facilities, electrification and huge irrigation
dams. Funds come from people in the form of taxes.

• The role of the government is to accelerate economic

development and to distribute equitably the fruits of
development among the various groups of society.
Fiscal Policy Objectives
• Provision for social goods
• Equitable distribution of wealth and income
• Maintain high employment
• Ensure price stability
• Sustain a satisfactory rate of economic growth
Fiscal Effects on the Economy

• Tax , cost of production, prices, income, purchasing power. These will

result to less savings and consumption.
• If there’s decrease in consumption, investment and production also
decrease.
• If savings decrease, funds that can be used for investments also decrease.
• These bad conditions of the economy started only from one source - the
increase of taxes. Hence, the indiscriminate use of tax measures should be
avoided.
Fiscal Effects on the Economy

Encourage Investments
• The government can encourage investments by giving tax exemptions or
reasonable taxes, and by extending the necessary external economies of scale
like transportation, communication, electrification, and peace and order.
• More investments mean more employments, more employments result to
more production of goods and services and generate more incomes, more
incomes result to people buying more goods and services.
• These lead to higher economic growth for the whole economy and higher
standard of living for people.
Fiscal effects on the Economy

Redistribution of Wealth and Income

• Another function of fiscal policy is to redistribute wealth and income fairly
among various groups of society. This can be attained through fiscal
programs like agrarian reform program, cooperative development program,
housing, education, and health programs.
• These projects or programs provide social goods and services to the poor.
• Such social welfare programs are funded by taxes paid by the people. Based
on the principle of ability to pay, the more fortunate pay higher taxes.
Weaknesses of Fiscal Policy

• Fiscal-policy making is more of a political rather than a market process.

• It is the assemblymen who introduce and decide tax and expenditure
measures. However, It is not possible to accommodate all the projects of the
assemblymen due to limited funds.
• During the old society, assemblymen who belonged to the minority party got
the remnants of the budget.
• Some politicians do not give projects to the places where they lost in the last
election.
Weaknesses of Fiscal Policy

Booms and Lags

• Increase of taxes and decrease in government expenditures are difficult to
implement. It is hard for most people to understand that such fiscal measures
are needed to reduce economic instability. They are more aware of the direct
and short-run effects on their welfare.

• Like Monetary policy, fiscal policy suffers a lag. This involves discussions of
the problem, the implementation of the appropriate fiscal policy, and its
subsequent effects on the economy.
₱₱ Weaknesses of Fiscal Policy

Other Shortcomings
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• The ability of a country to finance its various programs and projects depends
on its available resources and borrowings. Such resources come mostly from
taxes, and these are not enough to fund even the most essential projects.

• Many economists have observed that the tax administration in many less
developed countries is not only inefficient but also corrupt. The big shots do
not pay the right taxes because of their connections.

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 Weaknesses of Fiscal Policy

Dominance of indirect taxes ₱₱

• These are taxes on goods but businessmen pass them on to the
buyers by raising the prices of their goods. Examples are sales tax,
specific taxes, amusement taxes, and custom duties.

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• It is actually the buyers who pay their taxes. It is the poor who
finance the programs of the government like schools, hospitals,
housing, etc.

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Coordination between Monetary and Fiscal Policy

Both monetary and fiscal policies have the same objectives – the
attainment of greater economic growth. Hence there is a need for
cooperation and coordination between the two.

In many less developed countries, a harmonious balance between the

two policies is a difficult task to achieve. The authorities do not
cooperate in many cases for personal or political reasons. For
instance, it’s usual for such countries to spend their scarce financial
resources on unproductive programs and projects.
QUESTIONS?
THANK YOU!