Economic Policy. Sherif Khalifa. Sherif Khalifa () Economic Policy 1 / 25

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1 Sherif Khalifa Sherif Khalifa () Economic Policy 1 / 25

2 Issuer of currency, manager of foreign reserves, prints money and intervenes in foreign exchange markets to regulate the national currency s rate of exchange with other currencies. Banker to the government, as it provides bank deposit and borrowing facilities to the government. Banker to domestic commercial banks, as it provides bank deposit and borrowing facilities to commercial banks. Regulator of domestic financial institutions to ensure that commercial banks and financial institutions conduct their business prudently. Operator of monetary and credit policy, as it manipulate credit and monetary policy instruments to achieve macroeconomic objectives. Sherif Khalifa () Economic Policy 2 / 25 Economic Policy Central Bank is the major financial institution responsible for issuing a nation s currency, managing foreign reserves, implementing monetary policy, and providing banking services to the government and commercial banks.

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4 Monetary policy are activities of a central bank designed to influence financial variables such as money supply and interest rates. Money supply is the sum total of currency in circulation plus commercial bank demand deposits and sometimes savings bank time deposits. Monetary policy changes the aggregate supply of money in circulation and the interest rates by the central bank. Monetary policy plays a role in efforts designed to expand economic activity in times of unemployment and surplus capacity. Monetary policy plays a role in efforts designed to contract economic activity in times of excess demand and inflation. Sherif Khalifa () Economic Policy 4 / 25

5 By controlling the growth of money supply, policy makers can regulate their nation s economic activity. Expanded money supply induces expanded economic activity by enabling people to purchase more goods and services. Expanded money supply increases the supply of loanable funds, which lowers the interest rate. Private investment is inversely related to the prevailing interest rate, business people will expand their investments. Higher investment increases aggregate demand leading to a higher level of economic activity. Sherif Khalifa () Economic Policy 5 / 25

6 Contracting money supply aims at curtailing aggregate demand and curbing the inflation rate. Contracting money supply lowers the supply of loanable funds which increases the interest rate. Private investment is inversely related to the prevailing interest rate, business people will lower investments. The lower demand by consumers and investors will lower the inflation rate as well. Sherif Khalifa () Economic Policy 6 / 25

7 The ability to change money supply and interest rates is made possible by the existence of highly organized money and credit markets. Markets and financial institutions in developing countries are disorganized, and often externally dependent and spacially fragmented. The ability of developing countries to change money supply and interest rates is constrained by pegging their currency to the dollar. The commercial banking system in developing countries lacks transparency in their lending and credit policies. The commercial banking system restricts its activities to rationing scarce loanable funds to enterprises that are deemed more creditworthy. Sherif Khalifa () Economic Policy 7 / 25

8 It is inconvenient, ineffi cient, and risky to carry around cash to pay for purchased goods and services. The system channels people s savings to investors who need funds to finance their projects. Generating and distributing information about stocks and bonds prices, capital and credit. Channeling investment funds to uses yielding the highest rate of return allowing increases in specialization. Insurance markets and diversification provide protection against risk and uncertainty. Financial development increases liquidity by making it easier to sell assets. Sherif Khalifa () Economic Policy 8 / 25

9 A country s offi cial exchange rate is the rate at which its central bank is prepared to transact exchanges of its local currency for other currencies. Offi cial exchange rate is the rate at which the central bank will buy and sell the domestic currency in terms of a foreign currency. Free market exchange rate is the rate determined solely by international supply and demand for domestic currency. Sherif Khalifa () Economic Policy 9 / 25

10 Overvalued exchange rate is an offi cial exchange rate set at a level higher than its real or shadow value. Undervalued exchange rate is an offi cial exchange rate set at a lower level than its real or shadow value. Flexible exchange rate is the exchange rate value of a national currency that is free to move up and down in response to shifts in demand and supply arising from international trade and finance. Sherif Khalifa () Economic Policy 10 / 25

11 Offi cial foreign exchange rates are not necessarily set at or near the economic equilibrium price for foreign exchange. Developing countries opted for an overvalued exchange rate at a level of excess demand over supply of foreign exchange. Overvalued exchange rates lower the domestic currency price of imports below the level of a free market for foreign exchange. Cheaper imports are needed to fuel the industrialization process and import substitution. Overvalued currencies reduce the return to local exporters and to import competing industries that are not protected. Overvalued exchange rates have a tendency to exacerbate balance of payments and foreign debt problems. Sherif Khalifa () Economic Policy 11 / 25

12 Devaluation is a lowering of the offi cial exchange rate between one country s currency and all other currencies. Depreciation is the decline overtime in the value of one currency in terms of another as a result of market forces of supply and demand. An undervalued exchange rate is strongly export promoting. Because it increases the local prices that firms receive for goods that can be exported. This motivates a reorientation of firms toward the export market. Sherif Khalifa () Economic Policy 12 / 25

13 If the central bank decreases the interest rate, there is more capital outflow towards the higher return. The higher demand for foreign assets induces a higher demand for foreign currency. This increases the supply of the domestic currency causing it to depreciate in value. If the central bank increases the interest rate, there is more capital inflow towards the higher return. The lower demand for foreign assets induces a lower demand for foreign currency. This decreases the supply of domestic currency causing it to appreciate in value. Sherif Khalifa () Economic Policy 13 / 25

14 Fiscal policy is the determination by the government of the amounts of taxes (direct and indirect) to be collected and government spending (defense and nondefense). Government spending includes salaries to public employees, spending on public works and infrastructure, and defense spending. Direct taxes are those levied directly on individuals or businesses. Indirect taxes include custom duties, import tariffs, excise taxes, sales taxes, value added taxes, and export duties levied on goods purchased by consumers and exported by producers. Sherif Khalifa () Economic Policy 14 / 25

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17 Taxation potential of a country depends on: The level of real income per capita in a country. The degree of inequality in the distribution of income. The importance of different types of economic activity. The institutional setting and the relative power of different groups. The administrative competence of the tax gathering agencies of the government. The honesty and integrity of the tax gathering agencies of the government. Sherif Khalifa () Economic Policy 17 / 25

18 The high level of poverty with low incomes and diminished property values. The taxation system is regressive, not progressive, in developing countries. Power and influence of large land owning and dominant classes in developing countries. Tax incentives, exemptions and concessions to commercial enterprises and manufacturing firms. High levels of tax evasion by individuals and corporations due to the high level of corruption. The ineffi ciency, incompetence and lack of integrity of tax authorities. Sherif Khalifa () Economic Policy 18 / 25

19 As capital formation is essential at early stages of development when private savings are low, the state can provide funds for that purpose. They can absorb significant amounts of resources in developing countries, and provide employment opportunities for a huge labor force. Provide goods and services at affordable prices, as governmental control ensures that prices are not set above the marginal costs. The private sector has no incentive to produce goods that have high social benefit provided at low prices. The private sector has no incentive to engage in economic activities because of uncertainty about the size of local markets. The private sector has no incentive to engage in economic activities because of unreliable sources of supply, and absence of technology Sherif Khalifa () Economic Policy 19 / 25 Economic Policy State owned enterprises are public corporations owned and operated by the government.

20 Privatization is selling public assets to individuals or private business interests. Public enterprises make significant demands on government finance, while showing poor performance. Privatization hinges on the hypothesis that private ownership brings greater effi ciency and growth. Privatization hinges on the hypothesis that private ownership promotes individual initiative while rewarding entrepreneurship. Privatization is a means to broaden ownership and participation in the economy, thereby encouraging individuals to feel they have a stake in the system. Privatization is likely to increase the inequality, as privatized assets are being concentrated in the hands of small groups of local and international elites. Sherif Khalifa () Economic Policy 20 / 25

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