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Introduction to Economics
Egor Sidorov
Economic policy deals with …
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economic growth
price stability
interest rates
foreign exchange rate
employment
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Policy can either be expansive or restrictive
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1. Fiscal policy
2. Monetary policy
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Private and Public sectors
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Public expenditures
─ Current expenditures for:
─ goods and services,
─ interest payments,
─ subsidies,
─ transfers.
─ Capital expenditures.
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Macro-economic aspects of
public expenditures
─ Public expenditures are important part of total
incomes and expenses.
─ Public expenditures on goods and services (G) is an
important part of AD.
─ AD (aggregate Demand) = Aggregate Expenditure =
C + IG + G + NX
─ G influences employment and production in the
economy.
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Growth of public expenditures
─ demographic factors:
─ militant affairs,
─ inflation trends (higher costs for goods and
services),
─ technological changes (increased labour
productivity),
─ production volumes growth – increase of taxes,
─ political and social influences,
─ etc.
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System of public budgets
─ State budget,
─ Local budgets (regional, municipal),
─ Special centralized funds
─ i.e. in CR – National Property Fund, Land Fund, Environmental Fund
etc.
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State budget
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Passes in a Parliament as a law.
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The fact of approval law implies confidence in government
and its policy.
Budget is being approved for a Fiscal year
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USA: September – September,
Japan: March – March,
UK: April –April.
Any budget has 2 parts:
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Revenue side
Expenditure side
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Income of the State budget
─ Direct taxes:
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taxes on persons or property,
individual income tax,
employee social insurance tax,
corporate tax,
property tax,
─ Indirect taxes:
─ taxes on events or transactions,
─ employer payroll tax,
─ sales tax (including excise and value-added).
─ Other incomes for state budget:
─ Customs duties,
─ loans from abroad,
─ incomes from public offerings of state bonds
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Principles of taxation
─ Fairness, efficiency, purpose.
─ The benefits principle is the idea that people should
pay taxes based on the benefits they receive from
government services. (I.e. gasoline tax: revenues
from a gasoline tax are used to finance the highway
system).
─ The ability-to-pay principle is the idea that taxes
should be levied on a person according to how well
that person can shoulder the burden:
─ Vertical equity (progressive and regressive system).
─ Horizontal equity (equal conditions).
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State budget: Result of the
fiscal year
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Balanced budget
Surplus budget
Deficit budget
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Two types of deficits exist:
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State budget deficit compensation measures:
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Cyclical deficit – related to the business cycle.
Structural (active) deficit – related to the measures of the
economic policy (taxation, volume of expenditures…).
State bonds sale,
Loans from abroad.
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Fiscal Policy: Objectives and
Tools
─ Main objectives:
─ Balancing the budget (Pre-Great Depression)
─ Promoting full employment with price stability (Post
Keynes and WWII)
─ Eliminating critical points of economic cycles
─ Economical growth promotion
─ General tools:
─ Discretionary Fiscal Policy
─ Automatic Stabilizers
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Tools of Discretionary Fiscal
Policy
─ Government purchases
─ Transfer payments
─ Taxes and Borrowing
The government increases its purchases.
The aggregate demand function shifts up.
► Increased government purchases increase
real GDP.
► Increased real GDP increases disposable
income.
► Increased disposable income increases
consumption.
► Increased consumption increases real
GDP (The cycle continues).
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AD2
AD1
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Automatic Stabilizers
─ Automatic Stabilizers stimulate AD during periods of
recession and dampen AD during periods of expansion.
─ They do not require yearly congressional action to
operate.
─ Examples of automatic stabilizers:
─ progressive income tax with its increasing marginal income tax
rates,
─ unemployment insurance,
─ welfare spending.
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1. Fiscal policy
2. Monetary policy
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Money
─ Three main functions of money.
─ Accounting unit.
─ Everything in economic life can be measured by money.
─ Store of value.
─ You can hold your wealth as money.
─ Medium of exchange.
─ Money allows us to carry on purchasing transactions.
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What is money?
─ Money = everything used as a tool for exchange
─ Historical development:
─ Natural exchange.
─ Commodity money:
─ Many things have been money over the centuries: cattle, stones,
beads, iron, copper, zinc, cigarettes, silver and gold, ...
─ Gold and silver hold a place of special importance because they
─ are relatively scarce,
─ have a high value for unit of mass,
─ are easily divisible,
─ are durable and easily worked,
─ are considered rather valuable themselves.
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Gold standard
─ Up until quite recently, gold was money.
─ 1933 - the United States went off the domestic gold
standard. Gold was stored in government vaults, and in
it's place people were issued paper money which was
"backed" by gold or silver on a one for one basis.
─ 1973 - the U.S. left off the international gold standard.
─ This meant that gold and silver no longer had any
monetary role whatever. They became (and remain)
„normal” industrial commodities.
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Money aggregates
─ Transaction money M1:
High
─ Currency (paper bills and coins) is obviously the
most liquid of all assets.
─ Checking accounts (current accounts) are nearly
as liquid as currency (think of debit cards).
Liquidity
─ Broad money M2:
─ M1 (currency and checking accounts)
─ + deposits in saving accounts (short time)
─ Aggregate M3:
─ M2 + shares of money market, deposits in saving
accounts (long time) …, etc.
Low
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Monetary Policy
─ Main participant: Central Bank
─ Czech National Bank, Federal Reserve Bank, the Bank of
Canada, State Bank of Namibia…)
─ Functions:
─ Fights against inflation.
─ Promotes the efficiency of finance system.
─ Ensures financial system stability.
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Main Central Bank’s clients:
─ Commercial banks:
─ Transaction execution between banks.
─ Control of their assets and their performance.
─ The government:
─ Keeps it’s accounts.
─ Accumulates tax-income.
─ Other central banks.
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Demand for money
─ The demand for money is related with peoples
intensions to hold (save) or spend the money.
─ There are three reasons why people wish to
save/spend:
─ Transactions demand: demand for day-to-day money by
firms and households for buying goods and services.
─ Precautionary demand: demand for money by firms and
households caused by the wish to save money in case of
unexpected.
─ Speculative demand: this is demand for money as
financial asset for investment opportunities.
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How much money should be in
the economy?
─ The theory by Irving Fischer:
MV  PT
─ M-money in circulation,
─ V-velocity of circulation,
─ P-average price level in transactions made,
─ T-number of transactions.
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Direct (administrative) tools of
the monetary policy
─ tools limiting and influencing banking sector market.
─ These tools are used as exceptional and short term:
─ Mandatory structure of assets and liability for commercial
banks.
─ Credits, loans limits. One of the most tough direct tool.
─ Obligatory deposits – obligation for state institutions to
have account at the central bank (for example revenues
authorities, ministries, etc.).
─ Gentleman's agreements between central bank
commercial banks
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Indirect tools of the Central
Bank
─ Tools are influencing all participants of financial
market; they could be used without time limitation.
─ Basic tools:
─ Setting the Discount Rate
─ Reserve Requirements
─ Open Market Operations
─ Foreign exchange market operations
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Discount Rate
─ This is the interest rate the CB charges to banks
that borrow funds from the CB (bank rate).
─ ↑ discount rate > raise price of money > commercial
banks are lending lower amount of money > money are
„suck out“ from economy > money circulation slow down –
(anti-inflation) restrictive monetary policy;
─ ↓ discount rate > reduce price of money > commercial
banks are lending higher amount of money > money are
„suck in“ economy > money circulation speed up –
expansive monetary policy
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Required Reserves (RR)
─ This is the ratio of reserves to deposits required by
law. RR is very powerful and affects all banks
equally (as small change results in a large change
in money supply).
─ ↑ RR raise price of money > money are „suck out“ from
economy > money circulation slows down – (antiinflation) restrictive monetary policy;
─ ↓ RR > reduces price of money > money are „suck into“
economy > money circulation speeds up – expansive
monetary policy
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Open Market Operations
─ Central national bank buying and selling of bonds
(e.g. government securities) in the open market.
─ NB sells bonds, commercial banks pay money to
the NB, decreasing reserves.
─ CB´s sells bonds > raise price of money > money are
„suck out“ from economy > money circulation slow down –
(anti-inflation) restrictive monetary policy;
─ CB´s buy bonds > reduce price of money > money are
„suck in“ economy > money circulation speed up –
expansive monetary policy
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Foreign exchange market
operations
─ National Bank influences the national currency
exchange rate by using the direct market
interventions.
─ When the market experiences the lack of foreign currency
> the exchange rate tends to rise > the national currency
becomes cheaper > the CB enters the market and sells
it’s foreign currency reserves therefore supporting the
exchange rate.
─ When the exchange rate of national currency tend to
become very high due to the excess of foreign currency or
due to market agent’s expectations > the CB enters the
market and buys the foreign currency, increasing the
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Thank you for attention!
Refernces:
SAMUELSON, P. A., NORDHAUS, W. D. Ekonomie 18. vydání.
Praha: Svoboda, 2005.
KRAFT, J., RITSCHELOVÁ, I. Ekonomie pro environmentální
management. Ústí n. L.: UJEP, 2003.
MCDOUGAL LITTELL. Economics: Concept and Choices. Canada:
McDougal Littell, 2008.
www.iHNed.cz