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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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