Assignment Number:03

Macroeconomics
BS (Accounting and Finance) 4B

Submitted To:
Mr. Muhammad Husnain

Date of Submission:
May 9, 2024

Submitted By:
Bisma Saleem (22L-6322)
Monetary Policy:
Introduction:

Monetary policy refers to the activities taken by a central bank, such as the Federal Reserve
(Fed) in the United States or the European Central Bank (ECB) in the Eurozone, to regulate the
money supply, interest rates, and credit availability in an economy. The basic goal of monetary
policy is to maintain price stability (low inflation) while promoting long-term economic growth.

Tools of Monetary Policy:

 Open Market Operations (OMO): include purchasing and selling government securities
(bonds) on the open market. When the central bank purchases assets, it injects money
into the banking system, which expands the money supply. In contrast, when it sells
securities, it decreases the money supply.
Discount rate: the interest rate levied by the central bank on loans made to commercial
banks and other financial institutions. Adjusting the discount rate allows the central
bank to impact the cost of borrowing and lending in the economy.
 Reserve Requirements: Commercial banks must retain a specific percentage of their
deposits as reserves. By altering these reserve requirements, the central bank can
impact how much money banks have available to lend.
 Interest on Reserves (IOR): Central banks may pay interest on commercial bank
reserves kept at the central bank. By altering the interest rate, the central bank can
impact the number of reserves banks have and their readiness to lend.

Types of Monetary Policy:

1. Contractionary Monetary Policy: This sort of policy is intended to cut inflation and cool
an overheated economy. It entails lowering the money supply, increasing interest rates,
and tightening lending conditions. Contractionary monetary policy tries to restrict
expenditure and investment by raising borrowing costs, and delaying economic
development.
2. Expansionary Monetary Policy: Expansionary monetary policy is used to boost
economic activity and growth, especially during a recession or low inflation. It entails
expanding the money supply, decreasing interest rates, and loosening credit constraints.
This reduces borrowing costs, encouraging firms and individuals to invest more, and
increasing aggregate demand.
3. Neutral Monetary Policy: Neutral monetary policy aims to ensure economic stability
without favoring either contraction or expansion. The central bank changes its policy
 instruments as needed to keep inflation under control while promoting sustainable
growth and employment.
4. Unconventional Monetary Policy: Central banks may use unorthodox monetary policy
measures in extreme cases, such as a financial crisis or a lengthy economic slump.
Quantitative easing (large-scale purchases of financial assets to provide liquidity in the
economy), forward guidance (information about future policy goals to impact market
expectations), and negative interest rates (charging banks for retaining reserves).

Fiscal Policy:

Introduction:

Fiscal policy refers to the use of government spending and taxes to impact the economy. The
government implements it through financial choices. The primary aims of fiscal policy are to
achieve full employment, reduce inflation, and promote economic stability and growth.

Tools of Fiscal Policy:

 Government expenditure: Governments may have a direct impact on the economy by

raising or lowering expenditure on products and services. Increased expenditure can
boost economic activity and generate employment, whilst reduced spending can help
manage inflation.
 Taxation: Tax rate changes can have an impact on the economy's disposable income and
spending habits. Lowering taxes can boost consumption and investment, whilst boosting
taxes can lower inflation and government deficits.
 Transfer Payments: The government makes payments to people or groups for social
welfare, unemployment assistance, or subsidies. Adjusting the quantity and scope of
transfer payments can have a redistributive impact on consumer spending.

Types of Fiscal Policy:

1. Expansionary fiscal policy: entails increasing government spending and/or lowering

taxes to increase economic growth and aggregate demand. The expansionary fiscal
policy seeks to stimulate consumption, investment, and employment by increasing
government spending or putting more money in consumers' wallets through tax cuts.
2. Contractionary fiscal policy: employed to cool an overheated economy and keep
inflation under control. To reduce aggregate demand, the government spends less
and/or raises taxes. Contractionary fiscal policy tries to reduce the quantity of money
moving through the economy, limiting economic development and decreasing
inflationary pressures.

3. Automatic Stabilizers: These are built-in characteristics of the fiscal system that modify
government expenditure and taxation in response to economic developments. Examples
 include unemployment benefits and progressive income taxes, which rise during
economic downturns and fall during booms, therefore stabilizing aggregate demand and
supporting household incomes.
4. Discretionary fiscal policy: refers to intentional adjustments in government expenditure
and taxation implemented through legislative initiatives. Unlike automatic stabilizers,
discretionary fiscal policy actions are implemented by policymakers in response to
specific economic situations or policy objectives. These initiatives may include
infrastructure investment, specific tax cuts or credits, and changes in government
procurement laws.