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Foundation Economics Lecture 11
Foundation Economics Lecture 11
Foundation Economics Lecture 11
POLICY
Introduction
This unit introduces two major economic
policies - Monetary and Fiscal Policy - used by
countries to influence economic outcomes at
a macro scale. This unit begins with the
theories from two different schools of thought
(Classicals and Keynesians), which brought
into existence both policies. The Classicals
believe that the government should not
intervene in the workings of the economy,
while the Keynesians believe in government
intervention.
Monetary Policy
Monetary Policy (MP) is the responsibility of the
Central Bank of PNG (BPNG). BPNG is the monetary
authority on behalf of government. Prior to 1994, the
objectives of MP were to control inflation (price
stability) and maintain equilibrium in BOP. The
current MP objective is primarily achieving and
maintaining price stability (Central Banking Act
2000). MP involves regulating level of aggregate
demand and aggregate supply so as to maintain
price and exchange rate stability. This is achieve
through changes in money supply. Money supply
influences prices (inflation) and interest rates (cost
of borrowing, profitability of income, propensity to
save and invest and capital flows.
K
mill
ion
Demand deposits
1795.1
2214.7
Savings Deposits
429.1
Term Deposits
954.0
1477.2
5075.0
419.6
5075.0
Monetary Policy
In economics M1 is defined as the money
supply (demand deposits form a large part of
it). Central Bank targets demand deposit
components. Demand deposits also include
loans. Loans create deposits. Commercial
banks have the power to create deposits
through lending. The creation of an
oversupply of money will cause inflation.
Therefore the central bank exercises control
and control oversupply of money and bank
credit.
1
1
k
4; where d MLAR
d 0.25
4. Moral Persuasion
4. Moral Suasion or
Persuasion
PNG has come a long way since independence.
Electronic banking (automated teller machines ATMs)
with the use of debit cards have been introduced
recently in PNG. PNG also has its own stock exchange
market and the easing of exchange controls will
attract portfolio investment by foreigners in PNG.
In summary, the effectiveness of MP will also
depends on the investment climate and
opportunities, the responsiveness of speculative
investment to higher interest rates, inflation and
unemployment, the cost structure of the economy,
quality of manpower, law and order, political stability
etc. MP can not be pursued in isolation but part of a
policy package.
Fiscal Policy
1.
2.
3.
4.
1. Taxation
This is the primary source of revenue for the
government. There are basically 2 types of
taxes:
1. direct taxes (taxes on incomes)
e.g., wages and salaries tax and company
tax.
2. indirect taxes (taxes on goods and services)
e.g., sales tax, excise tax, import tariffs
- Excise taxes (levied at product or
manufacturing stage)
- Sales tax imposed at the stage of
distribution or sales
1. Taxation
Differences between the two types of taxes are
illustrated in Table below.
Direct taxes
Indirect taxes
Imposed on persons
May be proportional or
regressive (e.g., council tax)
1. Taxation
The following criteria must be present to allow
taxation to take place:
1. Efficient and cost-effective: Cost of
collection must be low. Direct taxes qualify.
2. Certainty: Must know in advance the tax
amount. With direct taxes, the degree of
certainty of X amount of taxes is very high than
indirect taxes.
3. Equity: Taxes should be levied according to
peoples ability to pay. Direct taxes meet this
criteria.
4. Convenience: taxes should be collected from
the people when it is most convenient for them
to pay. Direct taxes qualify.
Prior to the introduction of the goods and
services tax (GST), PNG had a very narrow tax
2. Government Expenditure
2. Government Expenditure
However, too often in LDCs, governments tend
to venture into the domain of the private
sector.
Public enterprises are run on commercial basis.
Examples of this in PNG are Ramu Sugar and
Air Niugini and business arms of provincial
governments.
Public enterprises have generally not done
well (e.g., PNG Power, Telikom etc) and most
have failed. Free market or some form of
privatization is now advocated in many
developing countries including PNG.
3. Borrowing and
Lending
Often borrowing takes place whenever there
is a gap between Revenue and Expenditure.
The government can borrow internally and or
externally.
Internal borrowing has a crowding-out effect.
If the government borrows from commercial
banks for instance, then less loanable funds
will be available to private investors or firms
who might want to borrow money to expand
their businesses or establish new entities.
For most LDCs lending is mostly internal,
e.g., the Rural Development Bank in PNG.
The debt problem in PNG appears to be rising.
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P3
P
D3
P2
D1
D2
A
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