Blogs on Accounting, Finance & Economics

Fiscal and monetary policies are macroeconomic tools in the hands of the government and central bank of a country to exercise control of the economy. Fiscal and monetary policies are formulated for controlling inflation, creating employment and increasing the growth prospects of an economy.  Fiscal policy is mainly concerned with government revenue and expenditure, and monetary policy deals with the circulation of money. While government departments usually have direct involvement in the formation of fiscal policy, monetary policy is formulated by the central bank of the country. Taxes on various goods are determined by the fiscal policy. Monetary policy determines the rate of interest charged by the banks.   What is fiscal policy? Fiscal policy deals with the revenue collection and expenditure by the government. A country's government plans how it will generate revenue for running the country. Taxes are the major source of government revenue. However, higher tax does not necessarily mean higher revenue. When people need to pay higher taxes, their disposable income reduces. This may lead to reduced consumption and savings. Reduction in consumption may affect government tax collection. A lower demand situation faced by the industry may also reduce the taxes paid by the corporates. The government needs to maintain a balanced approach in levying taxes on various goods and services sold in the economy. Taxes can be of two types; direct and indirect. Direct tax is based on the income of the people. The higher the income of an individual or the profit of a company, the more the taxes. Indirect taxes are taxes levied by the government on various goods and services sold in the country. As the taxes are collected not directly but through sales of goods, hence they are termed indirect taxes. The government determines tax rates. Fiscal policy also determines the expenditure of the government. The government needs to spend money on the salary of government employees, for the maintenance of government properties, roads etc. At the same time, the government can spend money on building infrastructure and productive capacity in the country. The latter may help more in achieving growth and developing the economy.   Fiscal policy, growth and development Economic growth can be achieved by increasing production, increased demand and consumption. Government expenditure often creates new jobs, new infrastructure and develops the economy. When government expenditure creates new jobs, people get more money to spend. This expands the economy and brings prosperity. Keynesian theory of macroeconomics suggests that even deficit financing can help an economy: when the government spends money beyond its means that can lead to more employment and the development of infrastructure, bringing an economy out of recession. Tax cut allows people to have more money in hand and consumption increases. An increase in consumption can make the factories expand their capacity and produce more. This may help in generating more investments.  In the case of tax concession to businesses, there are more investments and expansion of the businesses. Additional taxes usually contract the economy by reducing the demand for goods.   Fiscal policy and inequality Direct taxes are often called progressive and indirect taxes as regressive. The former taxes people as per their level of income. However, indirect taxes like value-added tax are levied equally on the rich and poor. Government has the opportunity of taxing the rich more and redistributing the money to the poor. The expenditure on creating universal health care or education system may help in creating opportunities for all sections of people in the economy and eventually reduce inequality. Government can also provide a universal minimum income to all citizens.   What is monetary policy? Monetary policy is the macroeconomic policy that deals with the circulation of money in an economy. Monetary policy determines the bank's interest rate. If the interest rate is high, people save more and reduce consumption. This reduces the money supply in the economy. Increased interest rates also make loans expensive and people do not prefer taking loans for buying consumer goods like cars or houses. Monetary policy also influences the currency exchange rate. When the interest rate in a country increases, foreign money in the economy increases, as investors prefer to earn higher interest. If the central banks stock more foreign currency, local currency may depreciate. When the central banks sell foreign currency in the market, it improves the value of the local currency.   Monetary policy and inflation Monetary policy is often used to stabilize prices and reduce inflation. Due to increases in interest rates, home loans, car loans, etc. become expensive. Consumers spend less and save more reducing the money supply in the economy. This enables checking the inflation. Inflation occurs when more money chases few goods (head to How Does Economics Explain Inflation? for more). Now as the money supply is cut down, inflation eases. However, an increase in interest rates may deter investors from taking fresh loans for investing in the economy. Reduction in the investment may reduce production and employment over a period of time which may create a situation where again inflationary situation arises due to a reduction in the supply of goods. Monetary policy can control inflation when it is due to excess money supply. However, it cannot solve the supply-side constraints.   Monetary policy and growth A monetary policy that wants the economy to be growth-driven works towards a low-interest rate regime. Lowering interest rates enable businesses to go for fresh investments, expand productive capacity and grow the economy. Lower interest rate encourages consumers to buy new cars, new homes and other consumer goods. These increase the demand in the economy. Higher demand and supply levels expand the economy. Economic growth can be achieved with monetary policy. However, increasing activities and increase in income may also have an inflationary effect on the economy.   Economic policies and influence of the state State economic policies try to ensure stability in the economy. It tries to reduce volatility. Volatility affects business as well as negatively impacts day to day life of the people. The state has monetary and fiscal policy tools to influence the economy. The effective implementation of monetary policy can cut inflation. It can bring in growth. Fiscal policies can expand the priority sectors of the government. It can also influence the consumption of certain products by a tax cut. Fiscal policy can create employment and bring prosperity to the economy. State influence on the economic front is exercised through fiscal and monetary policy measures. It is imperative that these policies are balanced to reduce uncertainty and volatility in the macroeconomic environment. Learn about macroeconomic policymaking and other rudiments of macroeconomics with Macroeconomic Essentials. Out now. Our book Macroeconomics Essentials You Always Wanted To Know brings you a multifaceted and holistic introduction to the realm of microeconomics. To know more about macroeconomic policies, policymaking tools, and how they impact our lives, head now to Amazon or Ingram to pre-book your personal guide to all the macroeconomic fundamentals.   Also read: Follow These Tips to Get Started (And Succeed) As An Online Entrepreneur What is Entrepreneurship and how do you set up a successful business? What is a Market in Economics?

Running up a credit card debt that cannot be squared off at the end of the month is not desirable, but it can be handled by a 25-year-old who just started her first job. She will be receiving a salary and probably has a few other expenses to worry about. If not this month, she is confident of squaring it off soon, even though she may need to pay additional interest as months pass. For a 70-year-old retired widower though, it can be the proverbial last straw. He does not have any new sources of income and is living off the savings he banked over a full working life. He needs careful budgeting to ensure he has enough money to support himself for the rest of his life. A sudden extra expense in the form of interest can upset calculations. If at all he needs to spend more money, he would rather do it from the money in his bank account. The interest foregone will be lower than the interest charged on an unpaid credit card bill. It is clear from the above example that financial decisions are based on an individual’s unique situation in life.  Among the various factors influencing financial planning, age occupies a position of prominence, requiring an adjustment to the strategies one adopts in making these decisions. The upcoming book “Personal Finance Essentials You Always Wanted To Know” deep dives into the world of financial planning for all individuals, no matter what stage of life they are at. This blog is a gist of the considerations that people in different age groups have for managing their personal finances. The New Adults (18 – 30 year-olds) In most cases, this is the period during which external support comes to an end and one begins to live independently. It could be a time when one needs to pay off the debts taken on for the purpose of education. The pursuit of higher studies to boost earning potential is also considered and, if found suitable, implemented. The focus should be on paying off student debts, if any, and creating a foundation for savings. This is the time when personal responsibilities, and expenses, are low, and it is possible to put away earnings. The earlier one starts saving the longer the runway it gets for growth and flight. Adulthood often comes with dealing with financial statements with no previous experience of it. Components of Financial Statements will help you get your basics cleared.   The Mid-Career Tricenarians (30 – 40 year-olds) This is the age where hopefully, the experimentations of early adulthood are over and one is settled into a life of one’s choosing. In short, you are now an active part of the commercial world, receiving money for your contribution and efforts, and paying money for buying the products and services produced by others. Responsibilities tend to rise during this period, with people starting families, buying homes, and having children. This increases the expenses. However, this is the time when one would also experience a rise in one’s stock. Long-term decisions like a home mortgage, children’s education, and insurance coverage may need to be taken during this period. A home mortgage leads to the acquisition of and creation of equity in a home, generally the single largest asset for most individuals.   The Peak Agers (40 – 50 year-olds) This may well be a continuation of the previous stage, excepting that you are likely to be better placed in financial terms with a rise in earnings while witnessing the build-up in the value of assets like home equity. Some people could use financial leverage to create larger assets, like trading the earlier house for a larger one. Some may need to put away money for foreseen expenses like the college education of children. Others could use this leverage for building more in terms of financial assets. It must be remembered that financial assets are what you will be relying on for earnings during your retirement years.   The Pre-Retirement Folks (50 – 65 year-olds) You will probably see your children become adults and leave the nest at some point during this phase. Some of your responsibilities will start coming down. However, some expenses, such as healthcare, do not come down. Also, it is difficult to reduce expenses related to the lifestyle that you have become used to. This is the time to assess your financial decisions and make changes, as required. You may also need to review your lifestyle and gradually move towards one that you will be able to sustain for many years during retirement. You don’t want to suddenly have to step down to a lesser lifestyle the day you retire. Your money accumulation rate could increase once again as your responsibilities decrease. However, at this stage, knowing that retirement is nigh, you are likely to be more responsible in your use of that money.   The Post-65 Retirers Time to sit back and relax?Physically yes, but financially no. Though the accumulation phase of your life is behind you, you need to continue to strive to ensure that you are able to lead a life in retirement that you wanted to and set yourself up for. This includes ensuring that you watch your expenses, and also review your investments to ensure they are yielding the right results. If not, you may need to move them around. You also need to take critical decisions such as optimization of the social security claim and estate planning that would smoothen the process of transition when you are gone.  Retirement also opens new doors for you. Read How To Get Back To Work After Retirement to know more.   Conclusion It must be noted that these stages are illustrative in nature. Many people go through one or more of these. At the same time, there are many others who do not adhere to them. Each person’s situation is unique, as is their capacity to handle risk and variance. A careful evaluation, supported by consultation with experts where required, should be the basis for financial decisions. Vibrant Publishers’ “Personal Finance Essentials” guidebook will help you understand everything related to money management. A financial journey can begin at any stage of life and it is the first step towards gaining financial independence and creating a secure future for yourself. Good luck! This blog is written by Ankur Mithal, author of the upcoming book Personal Finance Essentials You Always Wanted To Know.   About the Author  Ankur Mithal is a widely experienced business professional. In over 15 years with Standard Chartered Bank, he worked in Sales, Project Management as well as Operations, operating out of Kolkata, Delhi, Hong Kong, Mumbai, and Singapore. He was involved in a number of improvement interventions in the BPO industry that straddled the disciplines of Organizational Development as well as Quality which created interest and enabled him to learn about them. He is also the author of Organizational Development Essentials by Vibrant Publishers.