By | April 5, 2021

What is monetary policy?

Monetary policy is the set of tools, objectives and interventions undertaken to regulate the economy’s supply with financial assets in a continuous effort to maintain macroeconomic balances. Monetary policy aims at managing the economic conditions of the economy: money supply, interest rates and exchange rates, to achieve the objective of price stability in the medium and long term. It aims to maximize the impact on economic variables by changing short-term interest rates.

Monetary policy objectives are classified into final goals and intermediate objectives. The final objectives are price stability, higher employment, and balanced development. Monetary policy aims to achieve one or more of these objectives by maneuvering the money supply in circulation through the key interest rate, the money supply, or banks’ required reserves.
Usually, the main objective of monetary policy is price stability. Achieving such a goal is the most significant contribution that monetary policy can make to balanced economic growth over the medium term.

Since the price level results from market mechanisms and is not directly controllable by the Central Bank, it is necessary to set intermediate monetary targets. These objectives should promptly detect price evolution, be accurate and within the permissible error limits, and have a direct and consistent relationship with the final mark. However, the choice of the intermediate objective, i.e. the type and purpose of monetary policy to be implemented, depends on many mechanisms of transmission of financial decisions, where the most important are monetary targeting, which is based on the manipulation of money supply, and inflation targeting, which uses the interest rate level.

To achieve such objectives, central banks independent of the Treasury, which are usually entrusted with monetary policy, have two instruments at their disposal: money supply and interest rate. Central banks operate mainly through market operations: buying and selling securities, changing the volume of money supply and the interest rate level in the short run, increasing or decreasing required reserves in commercial banks, etc.

There are two types of monetary policy. It is considered a comprehensive economic policy that, through the reduction of the key interest rate, aims to stimulate the money supply from commercial banks to enterprises and, consequently, to stimulate investment and the production of goods and services. It is called restrictive a monetary policy that, by raising the interest rate, reduces the money supply in the market by increasing the cost of credit and consequently making investment and production less profitable. Restrictive monetary policies have the main objective of reducing inflation or slowing down economic growth in the event of overheating.

What is fiscal policy?

Fiscal policy and monetary policy consist of a set of instruments to change the state of macroeconomic indicators. The budgetary policy is expressed and based on relevant financial laws and consists of government intervention to cover state expenditures by administering revenues collected through the fiscal system. A typical and quite limiting problem that governments face in this area is tax evasion.

The objectives of fiscal policy may be numerous, but they are classified based on the three traditional functions of intervention that the state performs in the economic sphere:
a) the distribution function of the sources of financing necessary for the production of those goods and services which the free market is unable to supply effectively, including public goods, such as justice, national defence, road infrastructure, etc .;
b) the redistributive function, which aims at changing the distribution of income and property through the change of taxation of taxpayers’ sources of income;
c) the regulatory function of economic activity by changing the level of taxation or controlling macroeconomic aggregates.
Classification by functions is beneficial for a systematic analysis. Still, it should always be kept in mind because intervention in the state budget simultaneously produces effects on distributing resources, redistribution of revenues, and macroeconomic aggregates.

Fiscal revenues constitute the primary source of income of a state. Fiscal policy has the initial objective of guaranteeing minimum budget revenues. But from the moment that the state’s financial continuity is secured, the state sets other budgetary policy objectives.

Typically, there are two distinct and opposite positions in fiscal policy, which depend on political options, and each has its limitations. On the one hand, we have a fiscal policy, which relies on the relatively high fiscal obligation on large incomes, thus favouring redistribution of income in society; Its negative side lies in the limitation of cash that the “rich” can spend on investments, and as a result, this leads to a restriction of economic growth.

 

On the other hand, we have a uniform fiscal obligation, or “flat tax”, which preserves investment, but with potential negative consequences on consumption, i.e. on the middle and inferior classes, which make up the vast majority of consumers. The reduction of disposable income affects the decrease in demand in the market. As a result, we have a constraint on supply and, consequently, on production, investment, and economic growth. Between the two attitudes, different intermediate situations are undoubtedly possible.

Fiscal policy during the first half of 2009 was expansionary, characterized by a rapid increase in expenditures and the budget deficit. Budget revenues have marked a more moderate growth, partly reflecting the slowdown in economic activity. Although it remains within the planned level for the whole of 2009, the budget deficit of about ALL 30 billion is a much more prominent figure compared to the same period last year. In these conditions, the Bank of Albania would evaluate the taking of control measures within the planned levels of the budget deficit and public borrowing, helping maintain the economy’s internal and external balances. Maintaining planned budget parameters will positively impact macroeconomic stability by controlling fiscal stimulus on aggregate demand and reducing monetary markets’ pressure.

The demand for cash has increased in recent months. The increase of the money supply by about 8 per cent is based on the creation of money in the economy by the public sector and the private sector’s borrowing, mainly in lek. The loan portfolio has seen a modest increase of ALL 7.5 billion or about five times less than in the same period. The reduction of the source of banks’ funds and the rise of uncertainty in the country contributed to a significant slowdown in credit growth rates.

However, lending to the economy increased during the first months of the year, while the banking system signalled no further tightening of credit conditions during the third quarter and onwards. The demand for lek loans of the private sector has faced an increasing readiness of banks, thanks to the stabilization of the liquidity situation and the easing of monetary conditions in early 2009. The restriction of the money supply in foreign currency has resulted in the contracting of the money structure’s component currency structure in the direction of money demand, leading to the lek’s shift of the money supply structure.

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