Fiscal and monetary policies management in Bangladesh

Monetary policy control of money supply, fiscal policy control spending or acquiring money from public.

Many of you have heard about the Great Depression in the 1930s. The hardships that the developed world went through led to some serious thinking into the realm of economics with a view to avoiding such depressions in future. Prior to 1930, even the greatest nations of the world did not have a systematic way of economic management. The next few decades saw the birth of modern macroeconomics with concepts such as monetary and fiscal policies emerging.

So, what does this buzzword, macro-economic management, mean? Most of us want a better living standard for us and our families, no unemployment, no rise in prices of essentials and most importantly, building up our assets or wealth. These are precisely the objectives of macro-economic management i.e. control over variables such as growth, unemployment and inflation. It's time to think about how well we have been able to manage economic growth, unemployment and inflation in Bangladesh.

Let's not turn our attention to the 'how' part of the story. How does a government boost its economic growth, minimise inflation and maximise employment? Basically, it has two tools at its disposal, monetary and fiscal policies. Monetary policy means increasing or decreasing the supply of money in an economy. This is done by the central bank of a country. On the other hand, fiscal policy means governments will spend more or less money or collect more or less tax from the citizens. This is done directly by the political governments and is often guided by the political philosophies of the elected governments. In today's economies, we see a predominant use of monetary policies but balanced mix of fiscal and monetary approach is needed for proper macro-economic management, more so in a developing economy.

How does a central bank control the flow money into an economy? Well, there are several ways. Central banks control the amount of money in a commercial bank for lending by taking away a certain portion of the public deposits that banks receive. In technical terms, this is called maintenance of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). Currently, CRR is 6 percent and SLR is 13 percent in the country, totaling 19 percent. For islamic banks, SLR is 11.5%. This means that if you deposit 100 taka in my bank, I have to keep 19 taka with the central bank and the rest 82 taka is available for lending. By dictating these ratios, central banks control the amount of credit or lending in an economy, consequently the money flow. There are other tools as well. Central banks can increase or decrease its lending rate to commercial banks, which in turn induces commercial banks to increase their interest rates, effectively controlling the demand for credit or flow of money. Central banks can also borrow money from the banks through instruments such as auctioning of treasury bills, reverse-repo etc that impact the amount of money a commercial bank has at its disposal.

Tightening monetary policy means reducing the flow of money into the economy and accommodative or expantionary monetary policy means the opposite. Have you ever wondered how much money a country needs? Or, why don't central banks print unlimited amount of money to make everyone very rich? Well, money is only a medium for exchanging goods and services produced in a country, which is not unlimited. So, suddenly if people of a country have unlimited amount of money to buy limited quantity of goods and services, everyone will compete with each other to buy more by paying more to the sellers. As it is evident, more money is not helping us at all, only resulting in inflation or a price-hike. However, money supply has to increase with the increase in the level of economic activity in a country. From this discussion, it should be apparent by now that monetary policy can be tightened to control inflation in an economy. Higher interest rates will discourage consumer and business spending thereby reducing the pressure on price levels. Reducing business spending also has the flip side of increasing unemployment in the country. With that context, let us explore how a government balances between controlling inflation and increasing unemployment. This is where choices become difficult and we step into the world of normative economics or economic value judgments. Inflation is more immediately and easily visible to the ordinary masses while the impact of unemployment is deeper, long term and more harmful. A political party seeking easy popularity will obviously devote more resources into controlling inflation than addressing the issue of unemployment. How many times did you see the politicians inBangladesh making an issue out of rising price levels, and how many times about unemployment?

While monetary policy is a relatively new tool, fiscal policy measures have been around for quite a few decades now. A great economist called John Maynard Keynes popularised it. The tools of fiscal policy are government spending, taxes and subsidy. Objectives of fiscal policy measures are two-fold, stimulating economic activities and fixing the errors or failures of capitalism or market forces. In Bangladesh, government expenditure is done through annual revenue and development budget. Tax collection usually falls short of expenditure, leaving the budget at a deficit of roughly 4 percent. Governments can also change tax rates and consequently allowing individuals and businesses to have more or less money to spend or save. Bangladeshgovernment also gives indirect subsidies to people through state-owned enterprise for essentials such as power, diesel, kerosene, fertilizer etc.

How does a government spend more money? Well, it is quite often through increased spending on public infrastructures such as roads, bridges, ports, buildings etc, increased spending on public healthcare, education etc or increasing the size of the government by hiring more people and increasing their salaries. Generally, government spending has a positive impact on the output and employment level. For example, each road built creates employment for some workers. These workers in turn spend their income to buy other commodities, which stimulate other economic sectors as well. Therefore, every taka spent by the government trickles down to several levels. This called the multiplier effect of fiscal spending.

So, if the fiscal policy measures have such multiplier effect, why don't the governments spend all the money in the country and multiply the economic development many times over? Firstly, because the effect of fiscal policy measures is often short-lived.

Secondly, because governments often do not do a good job of allocating resources in different sectors. This is in fact best left to a market mechanism or the private sector. For example, an experienced and specialized company in automobile accessories is in a better position than the government to decide on how many batteries and tyres it will sell and in which market. Too much government spending is said to crowd out or discourage private sector investment. This reduces competition and therefore induces inefficiency in the system. The same goes for subsidies. State subsidised enterprises such as BPC, Biman, nationalised banks etc are major pockets of wasting our scarce economic resources. On the other hand, public spending on basic infrastructures, law and order, disadvantaged group education and healthcare would have far reaching and deeper impact, if done properly.

While both monetary and fiscal policies have got their respective advantages and disadvantages, they both complement each other and are essential for balanced macro-economic management. It is highly important that our policy formulators acquire the right skills, stay above undue influence and make the right decisions at the right time, even if some of those decisions are momentarily unpopular.

The writer is a banker. The write-up is the excerpt of a presentation made at a training session organised by Rahimafrooz (Bangladesh) Ltd.