Bilal Finl

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CHAPTER-I

INTRODUCTION

Macroeconomic policies are meant to achieve non-inflationary, stable growth and

employment generation. There are two major groups of policy instruments to achieve the

purpose; one is related to monetary conditions and the other to fiscal conditions. Fiscal policy

corresponds to taxation and spending decisions of the government, while monetary policy,

formulated by the monetary authorities, is related to the decisions regarding optimal amount of

money and interest rate prevailing in the economy. The objective of fiscal policy is to maintain

high employment level in the economy while that of monetary policy is concerned with money

creation, level of optimal interest rate and with level of inflation in the economy (Lewis and

Leith 2002). Moreover it incorporates numerous basic policy issues including appropriate size of

the state, the role of the government in accelerating economic growth, social development and

redistribution of the benefits of the economic growth, improving employment and social justice

inequality in income and wealth between income classes in present and future generations, and

ensuring efficiency by promoting optimum allocation of resources (Haq and Akram 2009).

Monetary policy is concerned with the measures used to regulate money supply and

credit in the economy with the aim to achieve outcomes of higher economic growth and price

stability. Beside the primary objectives of economic growth and price stability, the monetary

authority also aim at having interest rate stability, stability of financial markets, highemployment, and foreign exchange market stability. Although some of these goals are consistent

with each other as high employment is consistent with economic growth and interest rate

stability as associated with financial market stability, yet the situation is not always the same. At

times it so happens that a mutual conflict exists between the goals of price stability and interest

rate stability.

These conflicts are sometimes referred to as necessary conflicts and sometimes policy

conflicts. A necessary conflict reflects the situation when the achievement of one goal

necessitates the loss of another. The short term Phillips curve depicts such conflicts where a

trade-off is necessary between inflation and employment. A policy conflicts is a situation where

the conflicts is not necessary but monetary authority cannot pursue both goals simultaneously,

for example, growth and price stability. In a situation where economy is experiencing high

inflation and a slow economic growth rate, the authorities would be between the devil and deep

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sea. If they pursue tight monetary policy to curb inflation, the high interest rates will prove to be

a hindrance in the way of already slow economic growth. Conversely, if they pursue easy

monetary policy to accelerate growth process, lower interest rates will encourage inflation. Thus

the central bank is charged with the heavy responsibility of attaining multiple goals that either

necessarily or potentially conflicts with one another.

The central bank is unfortunate not to have direct influence on its goals of price stability

and high employment through its various policies. To meet this end, it employs a set of tools like

open market operations OMO, discount window lending, fractional deposit lending and some

other tools like morals suasion, direct action, publicity, changes in margin requirements,

consumer credit regulations that affect the goals indirectly after a certain time lag. Consequently,

central bank aims at variables that lie between its tools and ultimate goals. These variables are

called instrumental variables that the central bank uses to aim for intermediate targets like M1,

M2 or interest rates. But even these intermediate targets do not respond directly to the central

banks policy tools. Therefore, it employs another set of variables to aim at operating targets

such as reserves, monetary rather than directly hitting a goal.

The word fiscal is derived from the Latin word fiscus which means a rope basket into which

the public moneys were put (Seligman, 1950). The Roman applied this term for treasury in

England. Fiscal policy is defined as the discipline which deals with public household that is with

the revenues and expenditures of the state and the relations of the individuals to the public

treasury (Seligman 1950).

Fiscal policy is considered as a tool to control and adjust the human behavior which can

be affected by incentives provided by changes in government revenues and expenditure. Hence

fiscal policy deals with governments determination of the structure of taxes and government

expenditure and the methods of financing the budgetary deficit or allocating the budgetary

surplus to achieve certain macroeconomic goals e.g. creating employment and maintaining

economic stability.

In developed countries most important objective of fiscal policy is economic stability and

other important objectives includes better allocation of resources and more equitable distribution

of income. In developing nations, on the other hand, the most important objective of the fiscal

policy is the achievement of high economic growth and full employment in the economy, and

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other important objectives include mobilization of resources because developing nations are

always in short of funds.

Under fiscal policy size of the government expenditures is quite important. Some policy

makers suggest that cutbacks in government expenditures are justified by the low productivity

and inefficacy in these expenditures. Another view is that government plays a central role in

economic development and generating employment in the economy (Engen and Skinner 1998)

some policy makers argue (Mitchell 2005) government go down.

Monetary and fiscal policies are very closely related to each other despite the fact that

these two sets of policies are sometimes different in terms of scope, transmission mechanisms

and time involved in influencing the economic variables. Fiscal and monetary policies have

profound impact on level and composition of savings, investment, output and employment as

well as the viability of external account. The level and structure of taxation, magnitude and the

pattern of public expenditures, the dimensions of the fiscal deficit and the sources of financing it,

changes in money supply, availability and distribution of credit as well as its cost are major

determinations of the production structure and employment levels aside from their significant

impact on price level and movement of exchange rate.

The objectives and implications of policy measures taken by the two institutions often

conflict with each other and thus call for policy coordination for effective implementation of

policy decisions to achieve the set targets.

There are four main channels through which monetary policy simultaneously affects

output in case of Pakistan; namely the interest rate channel, asset price channel, credit channel

and exchange rate channel1. In this paper we unfold the impact of three of these channels i.e.

credit channel (M1 and M2), interest rate channel and exchange rate channel. Lastly we confirm

our findings by generating Impulse Response Functions (IRFs) in order to reaffirm the impact of

a monetary policy shocks on other economic variables.

Employment is the primary channel through which the majority of the population can

share in the benefits of economic growth. In particular, employment plays a critical role in

ensuring that economic growth translates into poverty reduction. However, the ability of

employment to reduce poverty depends on prevailing gender relations and intra-household

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dynamics. Therefore, any analysis that seriously considers the connections between growth,

employment and poverty reduction must incorporate a gender perspective or run the risk

reaching erroneous conclusions.

Consequently, low rates of inflation and control of the balance of payments have

prevailed, whilst investment and GDP growth have remained stagnant over a prolonged period.

Focusing on Pakistans fiscal deficit and the concurrent developments in the macroeconomy

between 1999 and 2002, this paper makes an attempt to ascertain whether there is a case for

relaxation of IMF conditionality and adoption of more expansionary fiscal policy (or a fiscal

tonic) to pursue greater development and productive investment expenditure in order to boost

employment through fostering growth.

Creation of employment has remained a top priory in developing countries like Pakistan.

A number of studies regarding growth and development have also focused on the labor market.

Because the main source of an individuals income is associated with employment opportunities.

Moreover, income and quality of job both affect social welfare significantly; employment and

economic development are concomitant.

If we observe the employment statistic of Pakistan is the 10 th largest country in the world

according to the size of the labor force. The labor total force is 53.72 million while 50.79 million

labor forces are employed and 2.93 million persons are unemployed, resulting in an

unemployment rate of 5.5 percent.

Figure 1.1 civilian labor force employed and unemployed (in Millions)

Years 2003-04 2005-06 2006-07 2007-08 2008-09 2009-10

Labor force 45.5 50.05 50.33 51.78 53.72 54.92

Employed 42 46.95 47.65 49.09 50.79 51.87

Unemployed 3.5 3.1 2.68 2.69 2.93 3.05

Source: Various issues of Labour Force Survey

In 2008-09, the labor force grew by 3.7%. The growth in female labor force was greaterthan male labor force and consequently the increase in the female employment was greater.

Employment comprises all persons ten year of age and above who worked at least one year hour

during the reference period and were either paid employed or self-employed. Labor force is

growing rapidly and there is a need of making policies to generate employment.

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In this spirit by observing the situation of the economy an attempt has been made in the present

study to estimate the behavior of fiscal and monetary policy and their impact on employment

generation.

1.1 Research of the Problem

This research study is titled as Role of fiscal and monetary policy in growth and employment

generation in Pakistan.

1.2 Objective of the Study

Following are the major objective of the present study:

How monetary and fiscal policy affect growth and employment in Pakistan.

What is the impact of fiscal and monetary policy in growth and employment generation in

Pakistan?

1.3 Significance of the Study

This study is important for following reasons:

This study shows a clear picture of growth and employment situation in Pakistan.

This study show how monetary and fiscal policies affect growth and employment generation

in Pakistan and which policy is best for Pakistan.

This study can be helpful to reduce unemployment and increase growth.

This study will assist the government and other job holder agencies to help to improve the

employment situation in Pakistan.

This study will recommend suitable suggestions for improving the situations.

The study is organized a follows: first chapter deals with the introductory section

regarding the policies employment situation in the economy. In the second chapter literature

review of the past research has been done to get the deep insight into the issues. Third chapter

deals with theoretical background. Fourth chapter is related to data and methodological issues.

The fifth and last chapter deals with the empirical analysis and the results and discussion matters

and in the last conclusion and policy recommendation are given.

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CHAPTER-II

LITERATURE REVIEW

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Employment has become important in the literature now-a-days. In the same way the

concern about the relative effectiveness of fiscal and monetary policy stance in relation to

employment has been the topic of debate among researchers since long ago. A cascade of

literature addressing the issue is on hand and the progress is still continued. A number of

economists assert about the positive role of government in stimulating economic growth, while

others challenge government intervention, considering monetary policy mainly responsible for

economic progress. However, an emerging group of economists now purports that a more

coordinated and co-operated fiscal and monetary policy can better do the job. In addition, the

available literature mainly relates to developed nations but a limited and few studies exist in

developing countries like Pakistan. No direct study on the topic is found in Pakistan. Here, we

present the review of some relevant studies both at the national and international level.

Khalid et.al, (2011) analyzed the relationship between economic freedom and pro-poor

growth: Evidence from Pakistan (1995-2010).The main purpose of this study was to investigate

the linkages between economic freedom indicators and pro-poor growth in Pakistan. Data for this

study was evaluated by pro-poor Growth Index (PPGI) in Pakistan, Economic survey of

Pakistan. Poverty and income inequality were used as dependent variables. The explanatory

variables were listed as Business freedom, Trade freedom, Fiscal freedom, Government size,

monetary freedom, Investment freedom, financial freedom, Poverty rights, and freedom from

Corruption. Ordinary Least Square (OLS) technique was used to estimate the results.

Assumption of the study was that the log of economic freedom used proxy for economic

freedom. The hypothesis of the study was that the total elasticity of poverty was greater than less

than and equal to the growth elasticity of poverty. The results showed that fiscal freedom had

positive and significant impact on poverty. The poverty rights had significant but negative

impact on poverty and the variable business freedom had negative and significant impact on

poverty. Trade freedom, Government size, monetary freedom, Investment freedom, financial

freedom and freedom from Corruption had positive but insignificant impact on poverty. While

investment freedom, financial freedom, and property rights exhibit a negative and significant

relationship with inequality and business freedom, trade freedom, government size, and

monetary freedom had positive and significant impact on inequality. Fiscal freedom and freedom

from corruption had positive but insignificant impact on inequality.

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Hussain (2007) analyzed the monetary policy channels of Pakistan and their impact on

real GDP and inflation. The main purpose of this study was an attempt to estimate the relative

impact of monetary policy on key economic variables i.e. output and inflation in Pakistan. The

dataset used for the regression analysis was largely extracted from the IMF dataset compiled by

the United Nations Statistical Database. The variables used were as follow inflation, exchange

rate, discount rate, real GDP, Monetary aggregate, output gap, CPI gap, and government

expenditure. Output gap and inflation are used as dependent variables. All other variables are

used as explanatory variables. For this analysis Vector Auto regression (VAR) approach was

used which was based on error correction model (ECM). OLS with hetroskedasticity robust

standard errors and corrected for serially correlated residuals using the pair- Winston iterative

process. Null hypothesis of study was that one co-integrating relation among the variables (r=1).

The results showed that due to the fact that exchange rate causing inflation gap through both real

GDP gap and directly simultaneously. It can be used as a suitable monetary policy instrument for

controlling inflation in the country. M1 and M2 had no significant impact. In the short run, there

was bidirectional granger causality from government expenditure to inflation and also between

inflation. Lastly, due to the unidirectional causality from inflation to output gap in the presence

of government expenditure it can be inferred that this policy variable was inflationary on the

average. Our findings maintained that the State Bank can also try to curb inflation by also

emphasizing on exchange rate as the monetary policy tool in case of Pakistan. This is because

the effect of exchange rate could not be accurately dissociated with inflation and output

consideration, given the possibility of supply side effects of exchange rate.

Ranit et.al, (2003) analyzed the public expenditure and emerging fiscal policy scenario in

India. The main purpose of this study was to find out the role of public expenditure and emerging

fiscal policy scenario in India. The secondary data had been drawn from the Federal Reserve

Bank of India. GDP was used as dependent variable and the explanatory variables were split into

gross capital formation in the public sector or public investment, real bank lending rate,

development expenditures, budget deficit, and revenue expenditures. Ordinary least Square

(OLS) method was used to obtain the results. Hypothesis of study was that govt spending had

negative impact on output. The results showed that public investment and development

expenditures had positive and significant impact on GDP. Real bank lending rate had negative

and significant impact on GDP. These results were similar to the previous studies. An analytical

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framework indicates that the various components of government expenditures may be identified

to have specific role in the pursuit of fiscal policy goals. The overall expenditure had shown an

upward movement till the mid- eighties. The macroeconomic crisis in the early nineties

necessitated fiscal consolidation which primarily came from expenditure composition

particularly in the capital outlays whereas increasing interest payments remained on the upward

trajectory. As a result, public expenditures witnessed a decline during the first half of the nineties

mainly on account of the central governments expenditures whereas the expenditure of state

governments had remained mostly stable in term of GDP. The development expenditure,

particularly in the social sector, has important implications for human development in India.

Muqtada (2010) had attempted to analyze the crisis of orthodox macroeconomic policy:

the case for a renewed commitment to full employment. The main purpose of this study or article

was examining the crisis of orthodox macroeconomic policy: the case for a renewed commitment

to full employment. The secondary panel data for 80 developing countries was taken from WDI

Database of the World Bank. GDP growth was used as dependent variable for this study and the

explanatory variables were split into investment, budget deficit, inflation, and current balance

account. Ordinary Least Square (OLS) regression was applied to obtain the results. The

assumption of the study was that several of the elements of Washington consensus were as valid

as today as when they were initially conceived. Hypothesis of study was that the instruments that

were used to attain stability had trade-offs. The results were similar to the previous studies and

show that investment had positive and significant impact in explaining growth. Budget deficit

and current balance account has negative and significant impact on GDP growth. Inflation has

positive but insignificant impact on GDP growth. The results showed that the instruments that

were used to attain stability had clear trade-offs. The consequences of these trade-offs were not

properly assessed or anticipated. Restrictive monetary policies often led to hike in interest rates

which adversely affected investment. Such orthodox procyclical policies usually included drastic

reduction in public spending to curb budget deficits. The drawback of the study was that during

economic downtowns and recessionary tendencies, counter- cyclical measures, including a

focused and well- targeted fiscal stimulus is critical in raising/sustaining aggregate demand,

GDP, growth and job creation. This lack of sensitivity in the stabilization policies, to how these

may affect aggregate demand is not only a shortfall in the orthodox macroeconomic policy

framework but is particularly verse when crisis hit country is struggling to recover.

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Raghav et.al, (2009) Analyzed the fiscal stimulus, agricultural growth and poverty in

Asia and the pacific region: evidence from panel data. The main purpose of this study was to

assess the impact of government expenditure on the growth rats of per capita GDP and

agricultural value added after controlling for the effects of other variables. The data for the

present study were taken from the IMFs Government Financial Statistics, Asian Development

Banks key indicators and World Development. The variables used in the present study were

agricultural value added per capita, and growth of per capita GDP are used as dependent variable

and total government expenditure, government expenditure on infrastructure, Net INF= total

government expenditure minus infrastructure expenditures, Trade, Debt ratio, working

population ratio, land per capita, initial GDP, initial AGP, crisis* Asia= Dummy variable for

whether a country belongs to Asia region and the period is 1997-8, crisis* sea= Dummy variable

for whether a country belongs to southeast Asia region and the period is 1997-8. Three Stages

Least Square (3SLS) estimators were applied here to estimate the results. Assumption of the

study was that trade share was used as proxy for openness. The saving glut is used as null

hypothesis. Results show a significant positive contribution of government expenditure to overall

economic growth. Agricultural growth appears to be negative associated with overall growth and

has significant impact. Crisis* Asia has negative and significant impact. Agricultural growth and

government expenditure has positive and significant role in per capita agricultural value added.

Initial agricultural GDP per capita has positive and significant impact. Trade share has negative

and significant impact on agricultural growth. Working ratio and land per capita has no

significant impact. The drawback of the study was that because of missing observations in

government expenditure data, it was difficult to construct annual time-series for most of the

countries.

Ogbole et.al, 16 February, (2011) analyzed the fiscal policy: its impact on economic

growth in Nigeria 1970 to 2006. The main purpose of this was study involves comparative

analysis of the impact of fiscal policy on economic growth in Nigeria during regulation and

deregulation periods. For this study the secondary data had been drawn mainly from the Central

Bank of Nigeria. For this study GDP was used as dependent variable and government

expenditure, private investment, inflation rate, dummy variable, capital inflow, random error

term, and export are used as the explanatory variables. The analysis involved stationary, co-

integration test, and Ordinary Least Square (OLS) regression. Augmented dickey-fuller (ADF)

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test was used, for co-integration the Johnson test was conducted to test for the long-run or

equilibrium relationship between the time series. Null hypothesis of the study was that there was

no significant difference in the effectiveness of fiscal policy on gross domestic product during

regulation and deregulation periods. Assumption of the study was that federal government

spending was used as proxy for fiscal policy. The results of ADF test showed that the variables

were all stationary or stable in the short run. The results of Johnson co-integration test showed

that in the model there was long-run relationship between the GDP variables. The results of OLS

estimation show that the model was of good fit because of high R2 value. The overall model was

also significant. The results show that the effect of government expenditure on GDP was positive

but insignificant which agrees our a priori expectation. The effect of private investment on GDP

was negative and significant. The effect of inflation rate on GDP was negative and insignificant.

The effect of capital inflow was negative and insignificant. The impact of export on gross

domestic product was negative and significant. The impact of dummy variable on GDP was

positive but insignificant. Drawback of the study was that there was a lack of needed

infrastructure. Through equilibrium relation exists between GDP and IFR it is not so strong

because of low R2. This weak equilibrium relation may be due to small n, the sample period n

is small.

Agha and Khan (2006) analyzed an empirical analysis of fiscal imbalance and inflation in

Pakistan. The main purpose of purpose of this study was that this paper investigates the long-run

relationship between inflation and fiscal indicators in Pakistan. The data for this study had been

taken from State Bank of Pakistan and the data of CPI has been collected from the Federal

Bureau of Statistics of Pakistan and represented by P. The data for fiscal deficit is collected

from the Ministry of Finance, Government of Pakistan. For this study the inflation was used as

dependent variable and the overall fiscal, (CPI) deficit, total bank borrowing, real GDP and

exchange rate were used as explanatory variables. For this study VECM model, Johansen co-

integration analysis, and the augmented dickey fuller (ADF) unit root test, to establish the

stationarity status of all the variables. The results of stationarity test apply on the data set. The

ADF test show that all the variables were integrated of order and they become stationarity at first

difference after including the distributed lags of one period. The Johnsen co-integration test

shows that fiscal deficit and total bank borrowing has negative and significant impact on

inflation. Real GDP had positive and significant impact on inflation. Exchange rate had positive

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and significant impact on the inflation. All of the variables were non-stationary at level, which

represents that they had time trend. Estimation of appropriate VAR model represented that model

had optimally tow lags. It means that a variable in period t is affected by other variables of

period t-1 and t-2 at maximum. Co-integration analysis represent that there was a long-run

relationship among inflation, fiscal deficit and total bank borrowing by the government. VECM

model suggests that the error correction coefficients were not significant and valid coefficient

restriction reinforce that only has significant error correction coefficients which implicitly

conclude that inflation is affected by the total bank borrowing as well as fiscal deficit. Both fiscal

deficit and total bank borrowing by the government sector were causing inflation.

Haq (2003) analyzed the fiscal strategy for growth and employment in Pakistan: an

alternative consideration. The main purpose of this study was to find out or estimate the fiscal

strategy for growth and employment in Pakistan. Aggregate time series data since were used,

primarily from various additions of the Pakistan economic survey, with some data extracted from

the State Bank of Pakistans annual reports and the Statistical year book of Pakistan. For this

study real private investment and the GDP growth were used as dependent variables and the

explanatory variables were split into gdp, fiscal budget deficit, inflation and availability of bank

credit to the private sector, growth of gross domestic fixed capital formation, the growth of the

labor force. The Ordinary Least Square (OLS) technique was used to regress each of the key.

The first relation we examine was between the fiscal deficit and the private investment. In this

model private investment depends upon gdp, budget deficit, inflation and credit. The results

show that because of high R2 and adjusted R2 values were indicative of strong goodness of fit of

the model to the data. GDP had positive and significant impact on real private investment and the

bank credit to the private sector also had significant but negative impact on real private

investment. Inflation and fiscal deficit itself had positive but insignificant impact on real private

investment. The second relationship which we examine was between the fiscal deficit and GDP

growth. In this model GDP growth depends upon growth of gross domestic fixed capital

formation, Growth of the labor force, XMGDP, and budget deficit. The results show that the

model displays a reasonable fit to the data with high R2 value. Growth of the labor force had

positive but insignificant impact on GDP growth. Investment growth had positive and significant

impact on growth of GDP. XMGDP had negative and significant impact on growth of GDP.

Budget deficit had positive but insignificant impact on GGDP. However, as long as Pakistans

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macroeconomic policy was bound by rigid conditionality over (growth include) productive

employment generating concerns, the opportunity present by such space may not be fully

exploited, if indeed at all.

Heintz (2006) analyzed the globalization, economic policy and employment: poverty and

gender implication. The main purpose of this study explored the growth-employment-poverty

reduction nexus through gender perspective. Panel Data on employment, disaggregated by sex,

were taken from the ILOs on-line database, LABORSTA. Data for the policy and economic

variables were taken from the World Development Indicators. The variables used in study were

employment, men employment, women employ, govt spending, exports, imports, out put, real

interest rate. Employment, men employment, and women employment were used as dependent

variables. Govt spending, exports, imports, and interest were used as explanatory variables. An

appropriate linear model was used. Unit root was employed and IPS procedure was used for

results. The null hypothesis was that a unit root exists. The results show that the impact of

output, govt spending and exports is positive and significant on total employment. While the

imports and interest rate was negative and significant on total employment. Impact of policy and

economic variables on mens and womens employment was as follow: - exports have positive

and significant impact on womens employment. Output and imports had positive but

insignificant impact on womens employment. Interest rate had negative and significant impact

on womens employment. The impact of govt spending on womens employment was negative

but insignificant. The impact of output, govt spending and interest rate was positive and

insignificant on mens employment. The impact of exports was negative and insignificant on

mens employment. The impact of imports on mens employment was negative and significant.

Drawback of the study was that, however, the exercise was highly aggregated and based on

pooled data from a diverse, yet limited, number of low-and middle-income countries. Therefore,

we were constrained in terms of what we can really take away from such a study.

Iqbal and Siddiqui, spring (1999) analyzed the impact of fiscal adjustment on income

distribution in Pakistan. The main purpose of this study was to find out the impact of a

quantitative assessment of selected fiscal adjustment on income distribution in Pakistan. The

secondary data for this study was taken from the Pakistan Institution of Development Economics

(1985), the Federal Bureau of Statistics (FBS), and Pakistan (various issues) Siddiqui and Iqbal

(1999). The variables used in this study are income distribution, tax revenue, government

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expenditure on (subsidies, health, education and others) and budget deficit. To obtain results a

latest social accounting matrix for the year 1989-90 and the static fixed price Ginni

coefficients approach was used. The results show that reduction in subsidies had more adverse

impact on the income of the rich and rural and urban households, implying that the richest people

in the country are the greater beneficiaries of subsidies provided by the government. The

evidence also suggests that a reduction in government current spending appears to had a negative

impact on all urban and rural household groups but the largest reduction appeared in the income

of the richest rural, followed by the poorest urban. Further, the estimates of Ginni-coefficients

show that reduction in consumption subsidies improves income distribution in both rural and

urban areas of Pakistan. Conversely, reduction in subsidies on production worsens income

distribution both in rural and urban areas, while reducing overall government expenditures leads

to deterioration of income distribution in urban areas but improves it in rural areas marginally.

Similarly, reduction in government expenditures on education and health adversely affects

income distribution in both urban and rural areas of Pakistan. Drawback of the study was that

however, this study captures only some of the main fiscal policy variables involved in structural

adjustment reforms, not all by any means.

Epstein and Heintz (2005) analyzed the monetary policy and financial sector reform for

employment creation and poverty reduction in Ghana. The main purpose of this study

summarized the findings and recommendations of a UNDP-supported study on linkages among

Central Bank policy, the financial structure and employment outcomes in Ghana. The secondary

data for this study is taken from the Central Bank of Ghana (CBG), World development

indicators and the govt of Ghana. The variables used for this study were interest rate, inflation,

growth, exchange rate, price of oil and money growth. These studies used vector error correction

model (VECM) to analyzed monetary policy. Initial diagnostic tests were applied on all

variables, unit root tests were performed on all variables. The null hypothesis of study was that

there was no granger causality. According to the adjusted dickey-fuller tests, none of these

endogenous variables had unit roots according to conventional levels of significant. Pair-wise

granger causality tests were also carried out on all the variables. The granger-causality tests

suggest that only a few of these relationships are granger- causal at standard significance

levels. The significance relationships were given as exchange rate causes growth, growth causes

exchange rate, money growth causes exchange rate changes, money growth causes credit growth,

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money growth causes t bills, economic growth t bills, economic growth causes money growth

and inflation causes credit growth. The granger tests find little support for the claim that

monetary policy had a direct link to economic growth or inflation; the main link, based on the

pair-wise tests, seems to be through its impact on exchange rates. The drawback of the study was

that the main problem is that the time period for the data series is relatively short so these tests

are subject to relatively few degrees of freedom.

Pickbourn et.al, (2005) analyzed the growth, investment and employment in Ghana. The

main purpose of this study was that this paper seeks to examine the formulation of national

policies including trade, exchange rare, monetary, and fiscal and labor market and how they had

contributed to growth and employment generation. The secondary data for this study was taken

from IMF/World Bank, World Development Indicators, Ghana Statistical Service and Bank of

Ghana. The variables used for empirical analysis for this study were total fixed investment,

current government expenditure, discount rate, annual percentage change in real GDP, real

exchange rate, total exports, credit extended to the public sector, credit extended to the private

sector. Investment was used as dependent variable for this study and all other variables were

used as explanatory variables. We used an augmented dickey-fuller procedure, with and without

a deterministic liner trend, to test for stationarity. The results show that all variables were non-

stationary with the exception of the growth rate. We can model the investment function

empirically as a long-run co-integrating relationship coupled with an error-correction model that

describes the adjustment to the long-run equilibrium. The results show that government spending

had positive and significant impact on investment in Ghana. The coefficient on the residual term

was both significant and negative. The drawback of the study was that the limited availability of

data for the entire period restricted the choice of variables. Unfortunately, the limited number of

variables and the relatively small number of observations prevent the application of more

sophisticated dynamic models.

Foley et.al, (1969) analyzed the optimal fiscal and monetary policy and economic

growth. The main purpose of this study was that this paper represents only the beginning of a

satisfactory theory of policy in an indirectly controlled market economy. The secondary data for

this study was taken from IMF/World Bank and Massachusetts Institution of Technology. The

variables used for this study were inflation, investment, growth, government expenditure,

burden of debt, fiscal deficit, private asset demand, capital stock, and per capita consumption,

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social rate of discount, private saving, technology, public credit, private credit, interest rate,

money growth, exchange rate and exports. The simple production model was used for this study.

The assumption of the study was that they assumed that the demand for consumption is

proportional to the disposable income which includes government taxes and transfers, made in a

lump-sum fashion. The results of this study model show that in this model the initial stock of

debt had no effect at all on the optimal growth path of consumption and investment. There was

no burden to the debt per se, although the accumulation of the debt may have been partly at the

expense of capital accumulation. The mixed economy with optimal monetary and fiscal policy

tends to a unique capital-labor ratio and a unique per capita government indebtedness which

were independent of initial endowments for the special case in which the instantaneous utility

function of per capita consumption had constant marginal utility, we show that the deficit

increases with the capital stock along the optimal path. The drawback of the study was that these

approaches fail to capture a central policy problem.

Tuck et.al, (May 3, 2009) analyzed the crisis in LAC: infrastructure investment and the

potential for employment generation. The main purpose of this study was that this paper

estimates the potential effects on direct, indirect, and induced employment for different types of

infrastructure projects LAC- specific variables. The secondary data for this study was drawn

from UNECLAC, IMF and country-level public expenditures. While the authors had used

UNECLAC, IMF and country-level public expenditures data to attempt to verify the

additionality of the stimulus announcements over originally budget expenditures. The direct and

indirect short-term employment generation was used as dependent variable for this study. While

the explanatory variables are split as the mix of sub sectors in the investment program, the

technologies deployed, local wages for skilled and unskilled labor, and the degree of leakages

imported inputs. In calculating secondary labor generation, a portion of machinery and

equipment inputs were assumed to be imported depending upon technology deployed in the sub-

sector providing a very basic discount for leakage. For this study using an input-output model

that considers all levels of inputs to construction, the US federal highway administration has

estimated employment generated supported from investment in highways. The results of this

study showed that the analysis finds that the direct and indirect short-term employment

generation potential of infrastructure capital projects may be considerable-averaging around

40,000 annual jobs per US$ 1 billions in LAC. Albeit limited in scope, rural road maintenance

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projects employ 200,000 to 50,000 annualized direct jobs for every US$ 1 billions spent. The

paper also described the potential risk to effective infrastructure investment in an environment of

crisis including sorting and planning.

Chaudhary and Chaudhary (winter 1992) analyzed the trends of rural employment and

wages in Pakistan. The main purpose of the present paper was to investigate the trends of

employment and wages in the rural areas of Pakistan. The secondary time series data for this

study had been taken from Pakistan Institute of Development Economics, Islamabad, Chaudhary

(1981), Government of Pakistan (1983-1990) and International Labor Organization. Labor

income was used as dependent variable for this study and the explanatory variables were split as

employment, CPI, wage rates, demand for labor, and supply of labor, agricultural output and

physical input of labor. No model was used for this study. The results showed that there is a

positive and significant relationship between agriculture output and demand for labor. The

results show that labor income was a positive function of employment and wage rates. As the

positive growth rates of job opportunities increases and wage rates were increases the income of

the labor also increases. It was found that the employment had been quite high despite the rising

unemployment and falling underemployment during most of eighties. While the high levels of

unemployment were attributable to limitations of the labor force approach as a measure of

employment in a less developed country. While the green revolution induced a strong demand

for labor in the rural areas in the sixties, it was complemented by a rapid expansion of the public-

sector employment in the early seventies and increased migration of Pakistani labor to Middle

East during most of 1970s. However, growth of demand for labor in agriculture, except in 1989-

1990, remained well above the increases in labor supply throughout the period from 1959-60 to

1984-85 and may have resulted in growing scarcities of labor. The drawback of the study was

that the analysis has been based on wage rates for casual workers and ignores wage rates for

permanent workers owing to the lack of consistent time-series data.

Ofoegbu (2006) analyzed the productive employment generation in a transition economy:

a Nigerian perspective. The main objective of this paper was to provoke some thoughts on the

foreign exchange market and monetary management in Nigeria. To achieve this objective, time

series data were obtained from the Central Bank of Nigeria. The variables used in this study were

money supply, trends of monetary policy instruments, the structure of output proxies by gross

domestic product, naira exchange rate, interest rate, reserve requirement, bank lending rate,

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saving deposit rate and inflation and population growth. No specific model and hypothesis was

used for this study. The assumption of the study in dealing with a topic like this one were as all

economic systems including that of Nigeria are in constant dynamic movement. Employment

generation can be a deliberate policy of government hence it was a function of economic

activities. Not all employment generated can be productive to the economic system. The results

showed that observed trends and variation in the exchange rate particularly within the structural

adjustment program (SAP) periods and post-periods, money supply and interest rate variations, it

was clear that the monetary policy instrument were not efficacious in the attainment of price and

exchange rate stability. Besides, growth in M1 and M2 causes inflation and there was an

established relationship among minimum reserve requirement (MRR), bank lending rate/saving

deposit rate on one hand and inflation on other hand. Above all, interest rates should be to the

benefit of the players/actors in the real sector. The drawback of the study was that the data on the

unemployment and other variables are not accurately available in Nigeria.

Tasneem and Waheed, (2006) analyzed the Sectoral effects of monetary policy: evidence

from Pakistan. The present paper takes a first step in investigating the monetary transmission

mechanism in Pakistan at a Sectoral level. Data on quarterly GDP and Sectoral outputs were

obtained from Kemal and Arby (2004). Data on nominal exchange rate, CPI, and call money rate

were obtained from IMFs International Financial Statistics. Data on all variables was checked

for seasonality and adjusted. The variables used in this study were real GDP, agriculture, mining

and quarrying, manufacturing, construction, wholesale and retail trade, finance and insurances,

ownership of dwelling, call money rate, consumer price index, and nominal exchange rate. For

this study we adopt a standard vector auto-regression (VAR) model. The assumption of the study

was that a shock to interest rate had no contemporaneous effect on output. Aggregate production

results show that the response of real output was consistent with existing evidence on the real

effect of monetary policy. The ADF test indicate that all data series were integrated of order 1,

except real output of finance and insurance sector which was stationary in levels. From the

estimated VAR, we generate impulse response functions and variance decompositions as a basis

for inferences. Results from the sub-sample estimation indicate major changes in the

transmission of monetary shock to variation in real activity. In particular, following monetary

tightening, aggregate output declines and bottoms out after 2 quarters. The manufacturing

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wholesales and retail trade, and insurance sectors seem to decline more in response to the interest

rate shocks.

Agha et.al, (2005) analyzed the transmission mechanism of monetary policy in Pakistan.

The main objective of this study was to disentangle and investigate the channels, using vector

auto regression, through which monetary policy shocks were propagated in Pakistan. The

secondary data for this study monthly data on private sector credit (loans) and real effective

exchange rate (REER) was from the State Bank, while data on Karachi stock exchange 100

indexes (KSEI) is from the Karachi Stock Exchange (KSE). The price level was given by the

consumer price index (CPI), which was gathered from Federal Bureau of Statistics (FBS). As the

data on GDP was not available on monthly basis, we used Industrial Production Index (IPI) as a

proxy to output. The variables used in this study were IPI: industrial production index, Loans:

private sector credit, prices: consumer price index (CPI), KEER: Karachi stock exchange (KES-

100) Index, TB6: 6-months treasury bill rates, and REER: real effective exchange rate. We

employed vector auto-regression (VAR) to examine the monetary transmission mechanism in

Pakistan. All the variables were seasonally adjusted and are in log form, except TB6. The

assumption of the study was that the movements in TB6 tend to lead changes in IPI and the

economy had a dynamic structure and was in part guided by the observations. The results

indicated that monetary tightening leads first to a fall in domestic demand, primarily investment

demand financed by bank lending, which translates into a gradual reduction in price pressures

that eventually reduce the overall price level with a significant lag. In addition to the traditional

interest rate channel, the results point to a transmission mechanism in which bank play an

important role. We had also found an active asset price channel. The exchange rate channel had

been less significant by comparison.

Khan and Senhadji (2001) analyzed the threshold effects in the relationship between

inflation and growth. The main purpose of this study was that this paper re-examines the issue of

the existence of threshold effects in the relationship between inflation and growth. For this study

the secondary data for these variables were taken from the IMFs International Financial

Statistics (IFS). The variables used in this study were inflation (), dlog GDP, initial income,

gross domestic investment over GDP, igdp, the growth rate of population (dlog pop), and the

growth rate of terms of trade (dlog tot). The dummy variable d* takes one for inflation rates

greater than the threshold estimate (*) and zero otherwise.. The dlog (gdp) was used as

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dependent variable and all other variables were used as explanatory variables. If the threshold

were known, the model could be estimated by ordinary least squares (OLS). Since * is

unknown, it has to be estimated along with the other regression parameters. The appropriate

estimation method in this case was non-linear least squares (NLLS). The hypothesis of study was

null Ho: r1=r2 and H1: r1r2. The study had no any type of assumption. The empirical results

strongly suggest the existence of a threshold beyond which information exerts a negative effect

on growth. The threshold was lower for industrial than for developing countries (the estimates

were 1-3 percent and 11-12 percent for industrial and developing countries, respectively,

depending on the estimation method). The threshold was statistically significant at 1 percent or

less. The negative and significant relationship between inflation and growth for inflation rates

above the threshold level was robust with respect to the estimation method, perturbations in the

location of the threshold level, the inclusion or exclusion of high-inflation observations, data

frequency, and alternative specifications interestingly, using yearly data yields threshold levels

that were closed to the estimates from the five-year-averaged data and a strong negative

relationship between inflation and growth. The drawback of the study was that the results were

informative. Some caveats were important to bear in mind when interpreting these results. First

that the estimated relationship between inflation and growth did not provided the precise channel

through which inflation effect growth. Second was that the coefficient estimates may be biased.

Ajisafi and Folorunso (spring 2002) analyzed the relative effectiveness of fiscal and

monetary policy in macroeconomic management in Nigeria. The main purpose of this study was

that the relative effectiveness of monetary and fiscal policy on economic activity in Nigeria was

determined through co- integration and error correction modeling techniques. Secondary time

series data employed were gathered mainly Central Bank of Nigeria (CBN) Statistical Bulletin

(1998). The variables used for this study were gross domestic product (GDP), narrow money

(M1) and broad money (M2), government revenue receipts (R), government expenditure (E) and

government budget deficit (BD) which was measured as (R-E) and were used as explanatory

variables. The empirical results of this study had been obtained through the use of PC_GIVE

computer package of econometric data analysis and estimations. Unit root tests also apply to test

the stationarity of variables. OLS and vector error regression model (VERM) and co-integration

regression were used in this study to obtained results. The null hypothesis of the study was that

all the variables were non-stationary and they were, indeed integrated of order1. The results of

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our analysis showed that monetary rather than fiscal policy exerts a great impact on economic

activity in Nigeria.

Gupta et.al, (April 2002) analyzed the expenditure composition, fiscal adjustment, and

growth in low-income countries. The main purpose of this study was that this paper or study

assess the effects of expenditure composition as well as fiscal adjustment on economic growth in

a sample of 39 low-income countries during the 1990s, The secondary panel data for this study

was taken from WEO Database, as well as Database for 39 ESAF and PRGE- supported

countries during the period 1990-2000 and from World Development Indicators of the World

Bank. The real per capita GDP growth was used as dependent variable for this study. The

explanatory variables used in this study are budget balance, tax revenue, and non tax revenue,

grants, current spending, capital spending, domestic financing, external financing, initial per

capita GDP, labor force, terms of trade, private investment, initial primary enrollment, initial

secondary enrollment, wage and salaries (as percent of GDP), interest payments, transfer and

subsidies, and other goods and services.. To obtained result baseline regressions and feasible

generalized least squares (FGLS), and OLS procedures were used. The assumption of the study

was that the error term is of the AR (1) form. The results from the baseline regressions were

consistent with the empirical literature and show that on average, fiscal adjustment had not been

harmful for growth, both in the long run and in the short run. According to these results a one

percent improvement in the fiscal balance had a positive and significant impact in the long run

on the rate of GDP growth. A similar result was obtained for short term effect of a change in the

fiscal balance on growth. Budget balance and capital spending had positive and significant

impact on per capita real GDP growth. Current spending and domestic financing had negative

and significant impact on per capita real GDP growth. Tax revenue had negative but insignificant

impact on per capita real GDP growth. All other variables had positive but insignificant impact

on real per capita GDP growth. The drawback of the study was that given the reduced form

model tested here, the paper had not examined the demand and supply side channels through

which fiscal policy affects growth, nor role of accompanying policies which had been

underscored in previous work in this field.

The review of literature showed that there had been extensive works, both theoretical and

empirical, on the issue relating to fiscal and monetary policy and employment. Fiscal and

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monetary policies play a significant role in achieving sustainable growth and better employment

position in the economy. A substantial different in the impact of fiscal and monetary policies on

employment are found in national and international studies. It was found that fiscal policy had

profound effects on employment.

While some studies have fevered monetary policy more effective while fiscal policy less

effective to effect economic growth in long run. Howe ever in studies relating to Pakistan it had

found that monetary policy is more effective in Pakistan.

The main hypothesis of study is the relationship between

fiscal, monetary policies and growth and employment in Pakistan. In perspective the present

study provides a fairly comprehensive picture of fiscal and monetary policies in Pakistan and

there impact on growth and employment.

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CHAPTER 3

THEORETICAL FRAMEWORK

Now after a detailed literature review and defining our research on impact of fiscal and

monetary policy on growth and employment generation in Pakistan, we can develop theoretical

frame work. The theoretical frame work enables us to understand the network of relationship

among fiscal policy, monetary policy, total government expenditures and money supply.

3.1 Concept of Employment

The act of employing and the state of being employed,the work in which one is engaged;

occupation,an activity to which one devotes time.The percentage or number of people gainfully

employed: "a vicious spiral of rising prices under full employment" (William Henry Beveridge).

3.1.1 Employment Definition

The state of being employed or having a job; "they are looking for employment"; "he was

in the employ of the city"

3.2 Self employment

An individual who operates a business or profession as a sole proprietor, partner in a

partnership independent contractor, or consultant. He/she must report self employment incomeon schedule.

3.3 Under employment

A situation in which a worker is employed, but not in the desired capacity, whether in

terms of compensation, hours, or level of will and experience while not technically unemployed,

the under-employed are often competing for available jobs. Those working few hours (daily,

weekly, or seasonal) than they would like to work. The visibly active but under utilized, those

who would not namely be classified by the above definition, but in fact have found alternative

means making time include the following. This is when people have a job but it is part time or

temporary. They would like to work full time, but only have a part time income.

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3.4 Full employment

In macroeconomics,full employment is a condition of the national economy, where all

or nearly all persons willing and able to work at the prevailing wages and working conditions are

able to do so. It is defined either as absolutely 0% rate of unemployment, as by James Tobin, or

as the level of employment rates when there is no cyclicalunemployment. It is defined by the

majority ofmainstreameconomists as being an acceptable level of natural unemployment above

0%, the discrepancy from 0% being due to non-cyclical types of unemployment. Unemployment

above 0% is advocated as necessary to control inflation, which has brought about the concept of

the Non-Accelerating Inflation Rate of Unemployment (NAIRU); the majority of mainstream

economists mean NAIRU when speaking of "full" employment.

FULL EMPLOYMENT, PRODUCTION POSSIBILITIES: Full employment is the condition

that exists when all available resources are engaged in the production of goods and services. In

other words, all resources that could be used for production are being used.

3.5 Definition of Unemployment

Unemployment is a situation which exists when members of the labor force wish to

work at the prevailing wage or salary rates for their skills, but cannot get a job. The concept

thus refers to "involuntary" unemployment only, rather than the voluntary decision of someone

to choose leisure (or productive activity outside the casheconomy such as housewifery) rather

than gainful employment at prevailing rates of pay. Unemployment is defined as a situation

where someone of working age is not able to get a job but would like to be in full time

employment.

One grey area is voluntary unemployment. This occurs when the unemployed choose not

to take a job the going wage rate (e.g. wrong job, benefits too high est.) They could be counted

as unemployed because they are still seeking a job (they just dont want to take one they are

offered.

3.6 Unemployment rate

A measure of the extent of unemployment in the labor force at some particular time,

expressed as a percentage of the total available labor force. Nearly all national governments now

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have some statistical agency or department charged with gathering the necessary data and

estimating the unemployment rate at frequent intervals (monthly or quarterly) for the guidance of

policy-makers. In broad terms the underlying concepts are pretty similar from one country to the

next: the number of people classified as unemployed is to be divided by the number of people

classified as being in the available labor force, with the result expressed in percentage terms.

However, differences from country to country in classification rules and practical data collection

methods used for estimating both the numerator and the denominator of this fraction make

precise international comparison of unemployment rates very difficult, if not impossible. The use

of jobless totals derived from the agencies that distribute unemployment insurance benefits is

particularly suspect but nevertheless widely practiced by some countries' official statistical

agencies. For example, some people may falsely claim they would accept a job offer at current

wage rates when in fact they are making no effort (or only a token show of effort) to locate such

a job, misreporting their intentions so that they may continue to draw unemployment benefits for

a time. Other people may be actively, even desperately, seeking a job and yet not show up in

such a count because they are technically ineligible forunemployment benefits (perhaps through

lack of previous work experience or through having exhausted the time-limit) and so do not

bother to report the success or failure of their job-hunting efforts to the government

unemployment office. (Well-designed sample surveys of the population or of employers have

much better validity for measuring the true unemployment rate but still have credibility problems

of their own. For example, hundreds of thousands or even millions of people who are really

gainfully employed but whose work is in illegal activities -- such as bootlegging, prostitution,

drug-dealing, loan-sharking, illegal gambling operations, smuggling, or simply working

conventional trades "off the books" to avoid taxes -- cheerfully deny having a job when

questioned by government pollsters in suits who might well inform on them to the police.)

3.7 Unemployed persons

Persons 16 years and over who had no employment during the reference week, were

available for work, except for temporary illness, and had made specific efforts to find

employment sometime during the 4-week period ending with the reference week. Persons who

were waiting to be recalled to a job from which they had been laid off need not have been

looking for work to be classified as unemployed.

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3.8 Measuring Unemployment.

Unemployment in the UK Is measured in two ways

1. Claimant Count number of people eligible for Job Seekers Allowance (note people may

be viewed as unemployed but not eligible for benefits)

2. Labour Force Survey A survey asking people whether they are out of work and actively

seeking work.

3.9 Types of Unemployment

Summary of Unemployment Types

Demand Deficient Unemployment. Lack of AD in economy (e.g. Recession)

Structural Unemployment workers lack necessary skills or geographical immobility

Real Wage Unemployment wages above equilibrium

Frictional unemployment workers in between jobs

Seasonal unemployment_ time of the years

Voluntary Unemployment. Workers prefer not to work.

Hidden unemployment.

3.9.1 Demand Deficient Unemployment

Demand deficient unemployment occurs in a recession or period of very low growth. If

there is insufficient Aggregate Demand, firms will cut back on output. If they cut back on output

then they will employ fewer workers. Firms will either cut back on recruitment or lay off

workers. The deeper the recession, the more demand deficient unemployment there will be. This

is often the biggest cause of unemployment, especially in a downturn. This is also known as

cyclical unemployment referring to how unemployment increases during an economic

downturn. Cyclical or demand deficient unemployment occurs when the economy is in need of

low workforce. According to the Keynesian economists this type of unemployment occurs due to

economic disequilibrium. This form of unemployment is most commonly known as cyclical

unemployment since unemployment moves with the trade cycle. The demand for labor increases

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with the economy in the boom phase. Again, when the economy passes though recession,

demand for labor contracts and the surplus is released as the unemployed labor force.

Diagram showing fall in AD and lower Output which leads to higher unemployment

3.9.2 Structural Unemployment

This is unemployment due to inefficiencies in the labour market. It may occur due to a

mismatch of skills or geographical location. For example structural unemployment could be due

to:

Occupational immobility. There may be skilled jobs available, but many workers may not

have the relevant skills. Sometimes firms can struggle to recruit during periods of high

unemployment. This is due to the occupational immobility.

Geographical immobility. Jobs may be available in London, but, unemployed workers

may not be able to move there due to difficulties in getting housing est.

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Technological change. If an economy goes through technological change some industries

will decline. This is likely to lead to structural unemployment. For example, new

technology (nuclear power) could make coal mines close down leaving many coal miners

unemployed. Structural unemployment arises when the qualification of a person is not

sufficient to meet his job responsibilities. Stated alternatively, structural unemployment

arises when the marginal revenue product of a person falls short of the minimum wage

that can be paid for the concerned job. The minimum wage is set by law or by

negotiations in the union. Structural unemployment can also accompany a situation of

zero minimum wages. The extent to which structural unemployment takes place depends

on a number of parameters. Higher the mobility of labor across different jobs, lower will

be the structural unemployment. Along with the mobility of labor, structural

unemployment also depends on the growth rate of an economy as well as the structure of

an industry.

3.9.3 Real Wage Unemployment / Classical Unemployment

This occurs when wages are artificially kept above the equilibrium. For example,

powerful trades unions or minimum wages could lead to wages above the equilibrium leading to

excess supply of labour (this assumes labour markets are competitive) Keynesian analysis

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suggests a fall in AD can lead to real wage unemployment as wages are sticky downwards and a

fall in AD doesnt lead to wages clearing. This type of unemployment problem arises when the

wages rise above the equilibrium full employment level. In such a situation the wages are not

flexible downwards which will imply that unemployment would persist for long. Such wages

may be set by manipulations in the trade union.

3.9.4 Frictional unemployment

This occurs when workers are in between jobs e.g. school leavers take time to find work.

There is always likely to be some frictional unemployment in an economy as people take time to

find a job suited to their skills. Frictional unemployment occurs when a person is out of one job

is searching for another. It generally requires some time before a person can get the next job.

During this time he is frictionally unemployed. The problem of frictional unemployment is

minimized with the development of efficient labor markets. The time period of shifting from one

job to another is almost nil. However, imperfect information may aggravate the problem of

frictional unemployment. The more developed an economy is, higher is the probability of getting

a job faster and lower is the probability of frictional unemployment.

3.9.5 Seasonal Unemployment.

In certain regions, unemployment may be seasonal e.g. unemployment rises in winter

when there are no tourists. There are certain kinds of unemployment that tend to concentrate in a

particular time of the year and are known as seasonal unemployment. Seasonal unemployment is

most common in industries like tourism, hotel, catering and fruit picking. Hence from the above

types of unemployment we may conclude that as long as demand supply gap persists in the labor

market, unemployment will exist. The pace of economic growth is also a factor contributing to

the different types of unemployment.

3.9.6 Voluntary Unemployment.

This occurs when workers choose not to take a job at the going wage rate. For example, if

benefits offer a similar take home page to wage tax, the unemployed may feel there is no

incentive to take a job.

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3.9.7 Disguised / Hidden unemployment.

Often unemployment statistics dont include certain types of workers. For example, those put onincapacity benefit may not be counted as unemployed, but, it may really be a type of structural

unemployment.

3.10 Fiscal Policy Definition

Government policies related to taxes, spending, and interest rates. Fiscal policy is intended

positively influence macroeconomic conditions. The primary debate within this field is how

active a government should be. Proponents of a tight fiscal policy argue that government actsbest when it acts least; they promote low taxes and spending and ideally limit government

involvement to the setting of prevailing interest rates. Proponents of a loose government policy

believe that government has a larger role in promoting economic well-being.

Or Decisions by the President and Congress, usually relating to taxation and government

spending, with the goals offull employment,price stability, and economic growth. By changing

tax laws, the government can effectively modify the amount ofdisposable incomeavailable to its

taxpayers. For example, iftaxes were to increase, consumers would have less disposable income

and in turn would have less money to spend on goods and services. This difference in disposable

income would go to the government instead of going to consumers, who would pass the money

onto companies. Or, the government could choose to increase government spending by directly

purchasing goods and services fromprivate companies. This would increase the flow of money

through the economy and would eventually increase the disposable income available to

consumers.

Unfortunately, thisprocesstakes time, as the money needs to wind its way through the economy,

creating a significant lag between the implementation of fiscalpolicy and its effect on the

economy.

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Definition: Fiscal policy refers to the government's handling of the budget. Usually fiscal policy

is about spending as much as possible, thereby stimulating the economy and increasing votes,

without raising taxes. This has led to an ongoing budget deficit and a huge debt. Like any budget,

fiscal policy guides two components: income and spending.

3.10.1 Objectives of Fiscal Policy

There are following objectives of fiscal policy:-

Development of Country:-

For development of Country, every country has to make fiscal policy. With this policy, all work

is done govt. planning and proper use of fund for development functions. If govt. does not make

fiscal policy, then it may happen that revenue may be misused without targeted expenditure of

govt.

Employment:-

Getting the full employment is also objective of fiscal policy. Govt. can take many actions for

increase employment. Government can fix certain amount which can be utilized for creation of

new employment for unemployed peoples.

Inequality:-

In developing country like India, we can see the difference one basis of earning. 10% of people

are earning more than Rs. 100000 per day and other are earning less than Rs. 100 per day. By

making a good fiscal policy, govt. can reduce this difference. Govt if makes it as his target.

Fixation of Govt. Responsibility:-

It is the duty of Govt. to effective use of resources and by making of fiscal policy different

minister's accountability can be checked.

3.10.2 The purpose of Fiscal Policy:

Reduce the rate of inflation, (UK government has a target of 2%)

Stimulate economic growth in a period of a recession.

Basically, fiscal policy aims to stabilize economic growth, avoiding the boom and bust

economic cycle.

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3.10.3 Fiscal Stance:

This refers to whether the govt is increasing AD or decreasing AD

Expansionary (or loose) Fiscal Policy.

This involves increasing AD,

Therefore the govt will increase spending (G)

and cut taxes. Lower taxes will increase consumers spending because they have more

disposable income(C)

This will worsen the govt budget deficit

3.10.4 Deflationary (or tight) Fiscal Policy

This involves decreasing AD

Therefore the govt will cut govt spending (G)

And or increase taxes. Higher taxes will reduce consumer spending (C) This will lead

to an improvement in the government budget deficit

Fine Tuning: This involves maintaining a steady rate of economic growth through using fiscal

policy. However this has proved quite difficult to achieve precisely.

3.10.5 Automatic Fiscal Stabilizers

If the economy is growing, people will automatically pay more taxes (VAT and Income

tax) and the Government will spend less on unemployment benefits. The increased T and

lower G will act as a check on AD.

In a recession the opposite will occur with tax revenue falling but increased government

spending on benefits, this will help increase AD Discretionary Fiscal Stabilizers

This is a deliberate attempt by the govt to affect AD and stabilize the economy, e.g. in a

boom the govt will increase taxes to reduce inflation

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Injections (J): This is an increase of expenditure into the circular flow, it

includes govt spending(G), Exports (X) and Investment (I)

Withdrawals (W): This is leakages from the circular flow This is household

income that is not spent on the circular flow. It includes: Net savings (S) + Net Taxes (T)

+ Net Imports (M)

Note Fiscal Policy was particularly used in the 50s and 60s to stabilize economic cycles.

These policies were broadly referred to as 'Keynesian' In the 1970s and 80s governments

tended to prefer monetary policy for influencing the economy.

3.11 Monetary Policy Definition

The regulation of the money supply and interest rates by a central bank, such as the Federal

Reserve Board in the U.S., in orderto control inflation and stabilize currency. Monetarypolicy is

one the two ways the government can impact the economy. By impacting the effective cost of

money, the Federal Reserve can affect the amount of money that is spent by consumers and

businesses.

According to Prof. Harry Johnson,

"A policy employing the central banks control of the supply of money as an instrument for

achieving the objectives of general economic policy is a monetary policy."

According to A.G. Hart,

"A policy which influences the public stock of money substitute of public demand for such assets

of both that is policy which influences public liquidity position is known as a monetary policy."

From both these definitions, it is clear that a monetary policy is related to the availability and

cost of money supply in the economy in order to attain certain broad objectives. The Central

Bank of a nation keeps control on the supply of money to attain the objectives of its monetary

policy.

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3.11.1 Meaning of Monetary Policy

The term monetary policy is also known as the 'credit policy' or called 'RBI's money

management policy' in India. How much should be the supply of money in the economy? How

much should be the ratio of interest? How much should be the viability of money? Etc. Such

questions are considered in the monetary policy. From the name itself it is understood that it is

related to the demand and the supply of money.

3.11.2 Objectives of Monetary Policy

The objectives of a monetary policy in India are similar to the objectives of its five year plans. In

a nutshell planning in India aims at growth stability and social justice. After the Keynesian

revolution in economics, many people accepted significance of monetary policy in attaining

following objectives.

Rapid Economic Growth

Price Stability

Exchange Rate Stability

Balance of Payments (BOP) Equilibrium

Full Employment

Neutrality of Money

Equal Income Distribution

These are the general objectives which every central bank of a nation tries to attain by empl

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