In this chapter you will learn the theory of liquidity preference as a short-run theory of the interest rate, analyze how monetary policy affects interest rates and aggregate demand, analyze how fiscal policy affects interest rates and aggregate demand, discuss the debate over whether policymakers should try to stabilize the economy.
Lecture 32 Monetary and Fiscal Policy Instructor: Prof.Dr.Qaisar Abbas Course code: ECO 400 Lecture Outline A Monetary Policy B Fiscal Policy Monetary Policy Monetary Policy • Monetary policy is concerned with regulation of quantity, cost and allocation of money and credit in the economy It is a mechanism, which has serious implication for economic development It helps individuals decide the amount and place of investment, rate of savings and spending Definition of Monetary Policy • • The actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates Monetary policy is maintained through actions such as increasing the interest rate, or changing the amount of money banks need to keep in the vault http://www.investopedia.com Monetary Policy • Money policy in many countries has been kept away from direct arena of government The government only establishes basic rules and eventual targets However, in Pakistan many policy has been a much more government controlled and influenced tool Monetary Policy – Interest rates have been pre-determined – Sector credit targets are defined – Market has not played an influential role The monetary management may be divided into two periods • • pre-1991 period Pre- 1991 Period • • Pre-1991 period – Before the 1991 financial sector reforms, the government’s management program was considered to be a loosely managed, highly unorganized system In 1972, when the banking reforms were taken, a National Credit Consultative Council (NCCC) was established to determine the distribution of credit in the economy – An annual credit was and still is devised each year to determine the extent of monetary expansion for the year The government administered all rates of return and the whole economy had to accept them It is far to say that Money Policy prior to 1991 worked fairly well and government had pursued an economic growth strategy : By controlling interest rates Post-1991 • Post-1991 – From 1991 till today the financial sector has been in the throes of major transformation The impetus to these drastic reforms is the World bank and International Monetary Fund Recent Monetary Policy Framework in Pakistan • • Objective(s) of SBP’s monetary policy is to strike a delicate balance on inflation containment and maintaining/supporting economic growth Change in the monetary policy stance is communicated through adjustment in the policy rate – the overnight rate at which SBP provides collateralized cash to bank(s) If required, changes in the Cash Reserve Requirement (CRR) and Statutory Liquid Reserve requirement (SLR) are also made 10 Other Objectives • To increase exports and control unnecessary imports • To minimize dependence on foreign aid and achieve self-sufficiency • • To provide inducement for saving and channel those savings into investment To increase per capita investment Tools of Fiscal Policy Fiscal Policy in Pakistan • • Fiscal policy relates to the government’s resource mobilization, collection and expenditure The government requires funds to finance public investment and social development schemes and day to day running of the government machinery Taxes are levied on incomes, profits, goods and services, which enable the government to carry out their services Fiscal policy also provides stabilization mechanism, which may be used to control and direct key economic variables such as inflation and unemployment Taxation system • Taxes have a far-reaching effect on the economy They influence savings and investment decisions in both private and public sectors There are three major groups of taxes responsible for much of the revenue collected in Pakistan: – Income tax – Sales and excise tax – Taxes on foreign trade SOME SALIENT FEATURES OF PAKISTAN’S RECENT TAX SYSTEM A FEDERAL Income Tax Heavy Reliance (53%) on Withholding/Presumptive Taxes • Progressive Personal Income Tax (max rate: 20-25%) • Corporate Income Tax (35% rate) • Universal Self-Assessment Scheme • Advance Tax Regime • General Sales Tax On Goods only • VAT features • Zero Rating, also of domestic sales of exporters • Standard Rate of 17% • • Exemptions to basic food items, agricultural inputs, medicines, newsprint SOME SALIENT FEATURES OF PAKISTAN’S TAX SYSTEM Custom Duty • Cascaded Tariff Structure (max rate: 25%; six slabs) • Tariff Peaks in Automobiles and other luxury goods • Share of Dutiable Imports (51%) Excise Duties • on few industries like cigarettes, beverages and cement • on Services in VAT mode • 1% Excise Duty across-the-board on manufacturing and imports B PROVINCIAL TAX-TO-GDP RATIO OF PAKISTAN 2000-01 To 2009-10 (% of GDP) Direct Taxes Indirect Taxes Surchar ge/Levy* Total Taxes FBR Revenue Share of Direct Taxes 2000-01 2.99 6.89 0.73 10.61 9.42 28.18 2001-02 3.20 6.41 1.23 10.83 9.11 29.54 2002-03 3.17 6.94 1.41 11.53 9.57 27.49 2003-04 2.92 6.84 1.09 10.84 9.25 26.94 2004-05 2.72 7.01 0.41 10.14 9.05 26.82 2005-06 2.82 7.06 0.67 10.54 9.36 26.75 2006-07 3.85 6.41 0.74 11.00 9.76 35.00 2007-08 3.79 6.47 0.34 10.60 9.83 35.75 2008-09 3.46 6.00 0.99 10.44 9.08 33.14 2009-10 3.66 5.83 0.90 10.39 9.05 35.23 Year * On petroleum products and natural gas Source: Ministry of Finance, Government of Pakistan THE IMBALANCED SECTORAL DISTRIBUTION OF THE TAX BURDEN 2004-05 (%) Share in GDP Share in Tax Revenue Ratio Agriculture 22.5 1.2 0.053 Industry 23.5 70.4 2.995 Services 54.0 28.4 0.526 Total 100.0 100.0 1.000 Source: Ministry of Finance, Fiscal Policy Statement Taxation system of Pakistan • Till date the taxation system of Pakistan is criticized on the following grounds – There is wide spread tax evasion – The proportion of indirect taxes in the total tax revenue is very high – The tax system is not elastic i.e government revenues not rise proportionally with rise in incomes Taxation system of Pakistan • • The need for reform in the tax system has been passing in recent years at government expenditures have increased and budget deficit is rising Fiscal deficit • The roots of fiscal deficit date back to the 1970’s.it originated to the eternally financed development spending in the form of investment by public enterprises RECENT REFORMS (2008-09 ONWARDS) Carbon Tax • Introduction of Fixed Levy on Petroleum Products as ‘Carbon Tax’ with large revenue yield of over Rs 110 billion ($1.3 billion) Direct Taxes • Taxation of (Short Term) Capital Gains on Shares • Extension of the Withholding Tax Net (Bank Cash Withdrawals, Air Travel) • Introduction of Minimum Tax on Turnover (of 1%) • Random Ballot for Audit with Outsourcing to private Accounting Firms • Detection of New Tax Payers through Collateral Evidence Sales Tax PROPOSED REFORMS Introduction of Comprehensive VAT (or reformed GST) • • • Objective is to broaden tax base and reduce tax rate (17% 15%) Elimination of exemptions on goods, except basic foodstuffs and life-saving drugs, could generate ¼% of GDP Enhanced coverage of services (excluding education and health) could increase tax revenues in the medium term by 1½ % of GDP • Reduction in tax burden on industry • Introduction delayed till 1st October 2010 due to ü ~ issue of collection by provinces of the sales tax on services PROPOSED REFORMS Provincial Taxes Areas of focus: • • • • Capital Gains Tax on Property Urban Immovable Property Tax Agricultural Income Tax The target in the on-going IMF Program is to raise the tax-to-GDP ratio by 3½ percentage points by 2012-13 References • • • Economics Survey of Pakistan (Latest Issues), Economic Advisor’s Wing, Ministry of Finance, Government of Pakistan www.investopedia.com Zaidi, S Akbar,(1999),“Issues in Pakistan Economy”, Oxford University Press .. .Lecture Outline A Monetary Policy B Fiscal Policy Monetary Policy Monetary Policy • Monetary policy is concerned with regulation of quantity, cost and allocation of money and credit... bps Recent Policy and Administrative Monetary Policy • Establishment of a Monetary Policy Committee (MPC) - A member MPC chaired by Governor SBP with two external academic experts - • Minutes... names) on monetary policy decisions posted on SBP’s website, increasing transparency of monetary policy formulation process and SBP’s credibility Frequency of Monetary Policy reviews and decisions