Fiscal Policy

Fiscal policy refers to the "measures employed by governments to stabilize the economy, specifically by manipulating the levels and allocations of taxes and government expenditures. Fiscal measures are frequently used in tandem with monetary policy to achieve certain goals. In the Philippines, this is characterized by continuous and increasing levels of debt and budget deficits, though there have been improvements in the last few years. The Philippine governments main source of revenue are taxes, with some non-tax revenue also being collected. To finance fiscal deficit and debt, the Philippines relies on both domestic and external sources. Fiscal policy during the Marcos administration was primarily focused on indirect tax collection and on government spending on ecnomic services and infrastructure development. The first Aquino administration inherited a large fiscal deficit from the previous administration, but managed to reduce fiscal imbalance and improve tax collection through the introduction of the 1986 Tax Reform Program and the value added tax. The Ramos administration experienced budget surpluses due to substantial gains from the massive sale of government assets and strong foreign investment in its early years. However, the implementation of the 1997 Comprehensive Tax Reform Program and the onset of the Asian financial crisis resulted to a deteriorating fiscal position in the succeeding years and administrations. The Estrada administration faced a large fiscal deficit due to the decrease in tax effort and the repayment of the Ramos administrations debt to contractors and suppliers. During the Arroyo administration, the Expanded Value Added Tax Law was enacted, national debt-to-GDP ratio peaked, and underspending on public infrastructure and other capital expenditures was observed.

Kinds of fiscal policy

Expansionary Fiscal Policy

Expansionary fiscal policy uses increased government spending, reduced taxes or a combination of the two. The chief objective of a fiscal expansion is to increase aggregate demand for goods and services across the economy, as well as to reduce unemployment. Governments often enact expansionary measures during an economic recession, when unemployment rises and output decreases. By boosting its own purchases of goods and services, government tries to stimulate the economy. During the 1930s, the U.S. government used expansionary fiscal policy to combat the effects of the Great Depression.

Expert Insight

Expansionary fiscal policy has a multiplier effect, in which each dollar spent by government generates additional demand across the economy, according to Professor Gregory Mankiw, a Harvard economist and former White House adviser. For example, if the Defense Department orders additional parts and equipment from a defense contractor, those purchases raise production and employment at the contractor. The firm's employees increase their spending on consumer goods, illustrating the multiplier effect resulting from a fiscal expansion.

Contractionary Fiscal Policy

When government policy-makers cut spending or increase taxes, they engage in contractionary fiscal policy. Governments may enact contractionary measures to slow an economic expansion and prevent inflation. In addition, governments may enact contractionary policy for ideological reasons. These include reducing the overall size and scope of government activity or lowering budget deficits, in which the government spends more money than it collects. The economics department at Harper College in Illinois points out that contractionary policy reduces aggregate demand in the economy, lowering inflation. But it may also lead to higher unemployment.

Considerations

Economic fluctuations independent of policy actions by government often affect the level of tax revenues, forcing elected officials to alter fiscal policy. For example, economic recessions reduce output and employment, resulting in reduced revenue for government coffers. This often forces policy makers to consider contractionary measures, such as increasing revenues by raising taxes or cutting government spending.

Monetary policy
Monetary policy is the monitoring and control of money supply by a central bank, such as the Federal Reserve Board in the United States of America, and the Bangko Sentral ng Pilipinas in the Philippines. This is used by the government to be able to control inflation, and stabilize currency. Monetary Policy is considered to be one of the two ways that the government can influence the economy the other one being Fiscal Policy (which makes use of government spending, and taxes). Monetary Policy is generally the process by which the central bank, or government controls the supply and availability of money, the cost of money, and the rate of interest.

Kinds of Monetary Policy

Bank Reserve Requirements

Through reserve requirements, the central bank requires banks and other depository institutions to hold a certain amount of funds in reserve to meet outflows of money, such as customer withdrawals. Banks may hold these reserves as cash in their vaults, as deposits with the central bank or as a combination of the two. When a central bank's policy-making body, such as the Federal Reserve Open Market Committee, wants to expand the money supply, it can lower reserve requirements. This puts more money into circulation by freeing banks to engage in more lending. Raising reserve requirements, in contrast, lowers the money supply by requiring banks to hold more money in reserve, making less available for lending.

Open Market Operations

An important type of monetary policy tool, open market operations involve the purchase and sale of government securities on the open market by central banks. In the United States, the Federal Reserve Bank of New York conducts open market operations. When the central bank wants to expand the money supply, it purchases securities from a bank, increasing that bank's reserves as payment. This gives that bank more reserves than it wants, freeing it to lend the funds. To reduce the money supply, the Federal Reserve sells government securities to banks and receives reserves as payment, which lowers those banks' supply of reserves.

Federal Funds Rate

The federal funds rate is an interest rate that banks charge each other for short-term loans. Federal Reserve policy makers adjust this interest rate in response to economic conditions. When inflationary pressures appear in the economy, the Federal Reserve often increases the federal funds rate, making it more expensive to borrow reserves and thus reducing the money supply. Lowering the federal funds rate expands the money supply.

Discount Rate

The discount rate is the interest rate that the Federal Reserve and other countries' central banking authorities charge banks and other depository institutions for borrowing reserves. The discount rate is typically higher than the federal funds rate, to discourage banks from turning to this lending source before other alternatives. Central banks can lower the discount rate, to expand the money supply, or raise the rate to reduce it.

Pamantasan ng Lungsod ng Maynila

Assignment In Economics
Ryan Joseph C. Tiaa BSCS IT II-2