3. What will you learn from this module?
• Explain the monetary policy instrument.
• Explain the effects of expansionary monetary policy on
the money market and goods market.
• Draw curves that describe the relationship between
money market and goods market.
describe the impact of the implementation of monetary
policy in AD and AS model (changes in AD and AS
curves)
• Distinguish expansionary monetary policy and
contractionary.
• Explain the impact of expansionary and contractionary
monetary policy on money market and goods market.
4. After studying this chapter, you will be
able to:
• Describes the tools of fiscal policy that taxes and
government spending
• Explain how fiscal expansionary policy implemented.
• Explain the crowding out effect.
• Describes the implementation of contractionary fiscal
policy.
5. Monetary Policy
Monetary Policy Tools
The Central Bank can influence Ms (increase or decrease)
in 3 ways:
• Open Market Operations (OMO)
• Reserve requirement rate (RR)
• Discount Rate (DR)
• For more information on What is Monetary Policy
• https://www.youtube.com/watch?v=bv-uNNkE39I
6. Monetary Policy
Expansionary Monetary Policy
• Implemented to increase the output / income of the
country.
• Using monetary policy tools for example buy bonds in the
OMO, ↓ RR and DR. This will lead to ↑ in Ms.
• Implemented during the economic recession / deflation or
high unemployment.
• When Ms ↑, r ↓, C ↑, I ↑, AD ↑, Y ↑.
8. Monetary Policy
Contractionary Monetary Policy
• Implemented to reduce the output / income of the country.
• Using monetary policy tools as selling bond in OMO, ↑ RR
and DR to ↓ Ms.
• Implemented during the economic boom / inflation.
• When Ms ↓, r ↑, C ↓, I ↓, AD ↓, Y ↓.
9. Monetary Policy
•Contractionary Monetary Policy
r
Ms0
MM0
e0
e1
AE0=C0+I0+G0
Md0
Y=AE
r0
r1
r
I
r1
r0
I0I1
AE
Y
e0
e0 e0e1e1
e1
Y
P
AD1AE1=C0+I1+G0
P0
Y1
Y1
Y0
Y0
Figure8.2 Contractionary Monetary Policy
Ms1
I0
M1
AD0
a) Money Market (Md=Ms) b) Investment Curve c) Y=AE Curve d) AD Curve
10. Relationship Between Product Market and
Money Market
PRODUCT MARKET
• Markets where the level of output is determined.
• Markets in which the occurrence of the sale and purchase of goods
and services.
Y = C + I + G + X - M
I + G + X = S + T + M
MONEY MARKET
• Market where the equilibrium interest rate level is determined.
• Markets in which the occurrence of such transaction / sale of
financial instruments.
Md=Ms
12. Relationship Between Product Market and
Money Market
Relationship between Interest Rate and Investment and Its
Impact on Product Market
• When governments implement expansionary
monetary policy, r will ↓.
• r affect the investment of the firm. When r is low, it will
encourage firms ↑ investment (I).
• When I ↑, AE also ↑, Y will ↑.
• This shows the changes in the money market also
affect the product market. .
14. Expansionary Monetary Policy
•The Effects of Expansionary Monetary Policy on the AD-
AS Equilibrium
Price Level (P)
P0
AD0
Y 0
SRAS0
Real GDP (Y)
The figure shows the effects of
expansionary monetary policy
during the economic downturn
and high unemployment. P0 and
Y0 is the initial equilibrium level in
the economy (AD0 intersect with
AS0). When CB implement
expansionary MP (buy bonds in
the OMO, ↓ RR, ↓ DR), Ms ↑, r
will ↓, I will ↑, AD ↑. When there is
an increase in AD (AD0 to AD1),
the level of output ↑ from Y0 to
YGTP. The same goes for a price
level.
Figure 8.5
Expansionary Monetary Policy
E0
E1
AD1
P1
Y GTP
LRAS
15. P0
AD0
Y 0
SRAS0
Figure 8.6
Contractionary Monetary
Policy
E0
E1
AD1
P1
YGTP
LRAS
Figure shows the effect of a
contractionary monetary policy
during inflation. P0 and Y0 is the
initial equilibrium level in the
economy (AD0 is the initial
equilibrium level in the economy
AS0). When CB implement
contractionary MP (sell bonds in
the OMO, ↑ RR, ↑ DR), Ms will ↓, r
will ↑, I will ↓ , AD ↓. When AD ↓
(AD0 to AD1), the level of output ↓
from Y0 to YGTP. The same goes
for the price level.
Contrationary Monetary Policy
The Effects of Contractionary Monetary Policy on the AD-
AS Equilibrium
Price Level (P)
Real GDP (Y)
16. Fiscal Policy
Fiscal Policy Tools
• Through fiscal policy, the government influence the economy
with government spending (G) and taxes (T), which will affect
income and influence other variables in the product market
and money market.
• Can be implemented separately or simultaneously.
• Expansionary policies (economic recession / unemployment):
↑ G and ↓ T.
• Contractionary Policy (Economics inflation / boom) ↓ G and ↑
T.
• For more information on Fiscal Policy Tools
• https://www.youtube.com/watch?v=otmgFQHbaDo
17. Fiscal Policy
Expansionary Fiscal Policy
• Expansionary policies (economic recession / high
unemployment): ↑ G and ↓ T.
• G ↑, AD ↑, Y ↑.
• T ↓, Yd (Y-T) ↑, C ↑, Y ↑.
18. Fiscal Policy
• Contractionary Fiscal Policy
• Contractionary policies (inflation): ↓ G and ↑ T.
• G ↓, AD ↓, Y ↓.
• T ↑, Yd (Y-T) ↓, C ↓, Y ↓.
19. Fiscal Policy
• Budget Definition
• The budget is " an expression of the Estimates of
Revenue and Expenditure for the year is used as a tool
for planning and management of economic resources to
meet people's needs ’
• For more information on Budget Deficit
• https://www.youtube.com/watch?v=3sUCSGVYzI0
20. Fiscal Policy
Element of Budget
• Policies , goals and strategies of the government to be
implemented in the next year budget.
• The program, activities and projects that will be
implemented to achieve the strategy and goals set.
• Distribution of financial resources in accordance with the
programs, activities and projects.
• How and how revenue collected to finance the programs,
activities and projects planned.
• Total financing from lending sources , and
Target output / impact .
21. Fiscal Policy
• Budget Components, Government Revenue &
Expenditure
• Budget Components
It comprises the Consolidated Fund which consists of:
• Revenue Components
• Loan Component
• Expenditure Components
22. Fiscal Policy
• Budget Components, Government Revenue &
Expenditure
• Revenue Components
These components consist of:
1) Tax Revenue
2) Non-Tax Revenue
3) Non Revenue Receipts
4) Revenue from the Federal Territories
23. Fiscal Policy
• Budget Components, Government Revenue &
Expenditure
• Budget Components
It comprises the Consolidated Fund which consists of:
• Revenue Components
• Loan Component
• Expenditure Components
24. Fiscal Policy
• Budget Components, Government Revenue &
Expenditure
• Budget Components
It comprises the Consolidated Fund which consists of:
• Revenue Components
• Loan Component
• Expenditure Components
25. Fiscal Policy
• Budget Components, Government Revenue &
Expenditure
• Expenditure Components
• Government expenditure consists of : -
• Operating Expenditure
• Liability expenditure
• Supplies Expenditure
• Development Expenditure
• Direct Development Expenditure
• Loan
27. • Increased borrowing, higher national debt and interest
payment.
• Increased AD, may cause higher inflation.
• Higher taxes and lower spending in future to reduce
deficit, so that will reduced incentive to work.
• Increased interest rate if government sells more bond in
order to attract investors to buy extra debt.
• Crowding out effects: when G ↑, AD ↑, Y ↑, MST ↑, Md ↑, r
↑, C and I ↓, AD ↓ and Y ↓.
Fiscal Policy
Effects of Budget Deficits
28. • Fiscal consolidation through reductions of subsidies and
additional taxes
• Enterprise creation, creating the auto-entrepreneur,
create model for the self-employed and designed for
persons going into business for themselves
• Enhance business competitiveness and productivity
• Expenditure restructuring and strategic distribution of
resources, focusing more on R&D and education.
• Cutting funds on ineffective programs/projects.
• Broadening the tax base as the GST.
Fiscal Policy
How to Reduce Budget Deficits
29. P0
AD0
Y 0
SRAS0
Expansionary Fiscal Policy
E0
E1
AD1
P1
Y GTP
LRAS
Figure shows the effect of
expansionary fiscal policy during
the economic downturn and high
unemployment. P0 and Y0 is the
initial equilibrium level in the
economy (AD0 intersect with AS0).
When government implement
expansionary FP (↑ G, ↓ T) AD ↑.
When there is an increase in AD
(AD0 to AD1), the level of output ↑
from Y0 to YGTP. The same goes
for the price level.
Expansionary Fiscal Policy
•The Effects of Expansionary Fiscal Policy on the AD-AS
Equilibrium
Price Level (P)
Real GDP (Y)
30. P0
AD0
Y 0
SRAS0
Figure 8.8
Contractionary Fiscal Policy
E0
E1
AD1
P1
YGTP
LRAS
Figure shows the effect of a
contractionary monetary policy
during inflation. P0 and Y0 is the
initial equilibrium level in the
economy (AD0 intersect with AS0).
When the governments
implement contracted FP (Lower
G and ↑ T), AD ↓. When AD ↓
(AD0 to AD1), the level of output ↓
from Y0 to YGTP The same goes
for the price level.
Price Level (P)
Real GDP (Y)
Contractionary Fiscal Policy
•The Effects of Contractionary Fiscal Policy on the AD-AS
Equilibrium
31. Crowding Out Effect
• That is a reciprocal effect on private consumption (C and I) when
the government impose fiscal policy.
• Some economists believe that if the government implemented an
expansionary fiscal policy, G ↑, AD ↑ , Y ↑, Mdt ↑, Md ↑, r ↑ and
eventually C and I will ↓ . This will cause AD to ↓ and Y also ↓ .
• 3 Types:
1) Complete crowding out effect (increase in G will offset by
the
fall of one or more private spending)
2) Zero crowding out effect (no effect stuffing out)
3) Incomplete crowding out effect (increase in G will only
reduced part of private expenditure)
Fiscal Policy
32. P0
AD0
Y N
SRAS0
The diagram shows how crowding out
effects happen. P0 and Y0 is the initial
equilibrium level in the economy (AD0
intersect with AS0). Expansionary
fiscal policy shifts the AD curve from
AD0 to ADN, the level of output
increases from Y0 to YN. This shows
zero crowding out effect.
In the event of incomplete crowding
out effect, AD will only turned into AD1
because of the initial increase in AD
compensated by the fall in C or I. So
there is only a small change in Y, from
Y0 to Y1. In the event of a complete
crowding out effect, , the initial
increase in AD will fully compensated
with fell in C and I. AD back to normal
and Y unchanged.
Crowding Out Effect
E0
E1
AD1
LRAS
P1
PN
Y 0 Y 1
EN
ADN
Price Level (P)
Real GDP (Y)
Fiscal Policy
• Crowding Out Effect
