Monetary and Fiscal Policies (26.2)

3 days ago

2 min read

Let's now start looking at how governments' policies can influence a country's economy. We will mostly focus on two types of policies:

Monetary Policies, that have to do with Interest Rates;

Fiscal Policies, related to Tax Rates and Government Spending.

Note:

Both of these policies are used by governments with the intention of achieving their economic objectives.

Monetary Policies is basically 'playing with interest rates' to achieve economic objectives by reducing the money supply in an economy.

First of all, what is the interest rate? There are two sides to it:

It impacts how much a company/individual will gain from having money deposited in the bank (savings);
As well as how much it will cost a company/individual to borrow from the bank (debt).

When the government increases interest rate in an economy - many consequences follow:

Reduced business/economic activity due:
Individuals and businesses are more likely to invest on savings and less likely to borrow;
Large amounts of savings strengthen the local currency (exchange rate): imported goods become cheaper;
Businesses invest less in local production because imported goods are cheap.

In summary, an increase in interest rates will lead to slower economic growth, appreciation of the country's currency, and a higher volume of imports.

Lowering the interest rate would have the opposite impacts:

- Economic growth can be boosted:

- Individuals and businesses are more likely to invest than saving;

- Currency depreciates (exchange rate);

- Imports become more expensive and local investment goes up;

- Country's exports become more competitive internationally;

- Cost of borrowing decreases.

Changes in taxes and interest rates don't hit every business the same way:

Non-Essential Businesses: Consumers can easily cut back on these items if income falls or prices increase;
Essential Businesses: Because these products are necessary for survival, people continue buying them even when prices go up.

Activity 26.5

Let's now jump in to Fiscal Policies, which is basically "playing with taxation to influence economic growth" as well as managing the government spending.

Taxes can be of two types:

Income Tax: taxing individuals which reduces disposable income:

Activity 26.2

Corporate Tax: taxing corporate profits, which decreases the profit after taxes of companies (lowering investments):

Activity 26.3

Fiscal Policies are not all about taxation - they also include government spending decisions - let's take Mongolia's Government Spending for 2021 as an example: