MONEY AND BANKING ASSIGNMENT

 

 
Topic:                                Explain Your Understanding of the terms monetary Policy  
                                          and fiscal Policy 

                                  Choose Any Two (2) of the Instruments to illustrate Your Answers having a defined economic Objective to achieve.

SOLUTION:

Introduction/Definition of Monetary and Fiscal Policy:

Economic policy-makers are said to have two kinds of tools to influence a country's economy: fiscal and monetary.

Economic, policy is dominated by monetary and fiscal policies.  Other policies include incomes, price employment, trade and industry.  Money supply and government expenditure are two cardinal tools of monetary and fiscal policies respectively.  Monetary policy is construed to be actions by the monetary authorities to influence the national economic objectives by controlling or influencing the quantity and direction of money supply, credit and the cost of credit.

Fiscal policy relates to government spending and revenue collection. For example, when demand is low in the economy, the government can step in and increase its spending to stimulate demand. Or it can lower taxes to increase disposable income for people as well as corporations.

Monetary policy relates to the supply of money, which is controlled via factors such as interest rates and reserve requirements (CRR) for banks. For example, to control high inflation, policy-makers (usually an independent central bank) can raise interest rates thereby reducing money supply.

These methods are applicable in a market economy, but not in a fascist, communist or socialist economy. John Maynard Keynes was a key proponent of government action or intervention using these policy tools to stimulate an economy in recession.

Fiscal policy is the use of government expenditure and revenue collection to influence the economy - manipulating the level of aggregate demand in the economy to achieve economic objectives of price stability, full employment, and economic growth.

On the other hand, Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest to attain a set of objectives oriented towards the growth and stability of the economy - manipulating the supply of money to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment.

DIFFERENCE WITH MONETARY POLICY AND FISCAL POLICY

Monetary policy is a term used to refer to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth. It established maximum employment and price stability as the macroeconomic objectives for the Federal Reserve; they are sometimes referred to as the Federal Reserve's dual mandate. Apart from these overarching objectives, the operational conduct of monetary policy should be free from political influence. Fiscal policy is a broad term used to refer to the tax and spending policies of the federal government.

The Federal Reserve uses a variety of policy tools to foster its statutory objectives of maximum employment and price stability. One of its main policy tools is the target for the federal funds rate (the rate that banks charge each other for short-term loans), a key short-term interest rate. The Federal Reserve's control over the federal funds rate gives it the ability to influence the general level of short-term market interest rates. By adjusting the level of short-term interest rates in response to changes in the economic outlook, the Federal Reserve can influence longer-term interest rates and key asset prices. These changes in financial conditions then affect the spending decisions of households and businesses.

Another key policy tool used by the Federal Reserve is the purchase of longer-term securities.  The Federal Reserve has undertaken purchases of longer-term securities to provide additional monetary policy stimulus to the economy. The Federal Reserve's purchases of longer-term securities are designed to help push longer-term interest rates lower. These actions encourage household and business spending through essentially the same channels as short-term interest rate policy. It is worth emphasizing that the monetary policy tool of purchases of longer-term securities is not comparable to ordinary government spending or other fiscal policy tools. In executing securities purchases, the Federal Reserve acquires financial assets that can be sold, not goods and services; thus, these purchases do not add to the government's deficit or debt.

THE INSTRUMENT

Monetary Instrument

Monetary policy deals with the discretionary control of money supply by the monetary authorities in order to achieve the desired economic goals. It could be seen that money policy comprises of those government actions which are designed in attempt to change the influence and the behaviour of the monetary sector of an economy. However, there are two views on the efficiency or monetary policy, monetarist and Keynesian view. The Keynesian view is that monetary policy should be direct towards interest rates rather than money supply and that the monetary policy should be subsidiary to fiscal policy. The monetarist recommends that the control of money supply should be the main concern of the money authorities. But it should be noted that money policy has a central role in macro economic management primarily because of the close relationship between the monetary aggregate and economic activity.

This is true irrespective of whether one is considering the monetarist or Keynesian framework. Although it may be desirable to introduce some monetary instruments -the environment for their effective application may not be suitable.

This fact should be borne in minds as we considered the application of various instrument of controlling money supply in the Nigerian economy. The Nigeria monetary system is part of the wider financial sector and its major operators are the monetary authorities, the banks merchant and commercial banks) as discount houses recently permitted to operate within the system.

The monetary authorities design and implement monetary policy and consist of the presidency, apex bank and federal ministry consist of these, the apex bank is the agency which is primarily responsible for designing monetary policy proposal for presidential approval and ensuring implementation of the monetary policy measures accepted by the federal government.

These goals of monetary policy remain the same irrespective of the package of instruments in use. The monetary policy attempts at maintain a balance as possible between the supply and demand for the monetary assets of the economy in order to achieve adequate economic growth. This broad purpose may be transmitted or rather translated into several specific objectives such as price stability, high level of employment or an acceptance  growth rate of the real gross domestic product (GDP), as well as balance of payment equilibrium.

Monetary management could take the form of direct or indirect control instruments comprising of interest rate registration, credit ceilings and sectorial allocation of credit. An indirect control instrument is mostly adopted by market based economy.  It has the advantage of the relationship between money supply and the monetary base and the ability of the monetary authorities to induce appropriate change in the monetary base. Banks reserves constitute an important component of the monetary base usually targeted by the monetary authorities to control the money supply in the Nigerian economic through the manipulation of the discount rate and reverse ratio. In Nigeria, the application of credit ceilings was designed to ensure that domestic credit expansion and the monetary implications of the balances of payment targets the expected increase in total demand for liquidity in the economy.

But Nigerian have decided to move away from indirect and direct monetary instruments under credit ceiling for instance, the apex bank found it increasingly difficult to achieve the stated monetary targets. The techniques of indirect monetary control basically involves the control of the money stock through the manipulation of the sources of the monetary base by the application Open Market Operation (OMO), reserve requirement and rate.

OMO is conducted mainly in the secondary market for government securities through the buying and selling of government securities, the apex bank directly changes the level of the bank reserves and indirectly induces changes in the level of interest rates, terms and availability of credit and ultimately the money supply.

In summary, a stimulative monetary policy is expected to improve the economy’s rate of growth of output (measured by Gross Domestic Product or GDP); tight or restrictive monetary policy is designed to slow the economy in the future to offset inflationary pressures. Likewise, stimulative fiscal policies, tax cuts, and spending increases are normally expected to stimulate economic growth in the short run, while tax increases and spending cuts tend to slow the rate of future economic expansion.

REFERENCES

Mohammed, U.D. Saidu S.A., Nuhu M., Aina O.K. (2014) Money and Banking in Nigeria,  Ollyprint Published Limited,: Gwagwalada, Abuja, Nigeria.   

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