• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

Why is Control of Budget Deficits Argued to be Central to the Control of the Money Supply in LDC's? Is this a Strong Argument?

Extracts from this document...

Introduction

WHY IS CONTROL OF BUDGET DEFICITS ARGUED TO BE CENTRAL TO THE CONTROL OF THE MONEY SUPPLY IN LDC'S? IS THIS A STRONG ARGUMENT? A budget deficit is the excess of government expenditure over government taxation and any other receipts, in any one fiscal year. The operation of a budget deficit is a useful tool of fiscal policy to enable government to influence the level of aggregate demand and employment in the economy. J.M Keynes advocated this policy in the 1930's to offset the depression that occurred at the time. Prior to this, it was often thought that the government should operate a balanced budget policy, allowing the economy to respond in its own way without government intervention. Keynes argued that government should intervene by deliberately imbalancing its budget in order to inject additional aggregate demand into a depressed economy and vice versa. The money supply is the amount of money in circulation in an economy. Money supply can be specified in a variety of ways, and the total value of money in circulation depends on which definition of the money supply is adopted. 'Narrow' definitions of the money supply include only assets possessing ready liquidity, such as notes and coins. 'Broad' definitions include other assets, which are less liquid but still important in strengthening spending, for example, building society deposits must be withdrawn before they are converted into notes and coins. ...read more.

Middle

In the revenue tax collections the share of excise duty has come down from 43% in 1991 to 37% in 1996 and that of customs collections has come down from 36% to 32%, while the share of direct taxes has gone up from 18% in 1991 to 29% in 1996. The 'Broad' money supply has increased in first quarter of 1997 mainly due to 20% increase in RBI credit to the government to finance the budget deficits which in turn increases the money reserves. In the interim credit policy announced by RBI the cash reserve ratio was reduced by 1% to 12%. This along with easing of the tight liquidity situation, led to fall in money rates. As a result of this, RBI credit to the commercial sector fell by 24%. Though year on year 'Broad' money (M3) growth has been 16%, the growth since 31st March'96 has been only 3.5%. Where, reserve money has increased by 7.7%, since 31st March 1996. We expect the 'Broad' money to further rise and thus put a downward pressure on interest rates. 1) The budget has largely been anti-inflationary by reducing customs and excise duties across various raw materials and items of daily usage like detergent, toothpaste etc. 2) The budget recognised the need for infrastructure development to facilitate economic growth and have several provisions to encourage investment in infrastructure. ...read more.

Conclusion

The decrease in the money stock would offset the rise in velocity associated with deficit-induced increase in the interest rate. The deficit would then have no effect on nominal national income. Consequently, neither real output nor the price level would increase, even in the short-run. To maintain price stability in the long run, the rate of growth of the money stock and nominal income would have to be adjusted to allow for any slowdown in the growth of real output. Theoretically, the appropriate monetary policy could insulate the price level from the impact of the federal deficit. We see that the effects that the budget deficit has on the money supply are fairly vital and therefore may even be considered as 'central to the control of the money'. As for the strength of this argument, I believe that from the above examples, the importance of the budget deficit to the control of the money supply is fairly evident. APPENDIX 1 INITIALS DEFINITION Narrow' Money Money held predominantly for spending Bank notes and coins in circulation M0 Currency plus banks' till money & operational balances at Bank Of England M1 M0 plus UK private sector sight Bank deposits M2 M1 plus UK private sector Deposits in banks & building Societies 'Broad' Money Money held for spending &/or as a store of value M3 (formerly sterling M3) M1 plus UK private sector time Bank deposits & UK public sector sterling deposits M4 M3 plus net building society Deposits M5 (formerly private sector liquidity) M4 plus UK private sector Holdings of money market Instruments (e.g. ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our GCSE Economy & Economics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related GCSE Economy & Economics essays

  1. Economics - Classical School of Thought, Keynesian School of Thought, Supply Side School of ...

    Monetarists argue that government has promoted downward wage inflexibility through the following programs: minimum wage law, pro-union legislation, guaranteed prices for certain farm products, and pro-business monopoly legislation. Monetarists believe that the government has negatively impacted economic business cycles through its mistaken attempts to achieve greater stability through its economic policy.

  2. Causes of the Great Depression

    Without a car people did not need fuel or tires; without a radio people had less need for electricity. On the international scene, the rich had practically stopped lending money to foreign countries. With such tremendous profits to be made in the stock market nobody wanted to make low interest loans.

  1. Retailing In India - A Government Policy Perspective

    This demographic segment, which is widely believed to be a main driver of the global retailing industry, has been rapidly growing at a pace of 10% per annum over the past decade. Also of significant importance is the rise in the affordability of the Indian consumer.

  2. Describe various methods that could be used to prepare a preliminary budget for a ...

    to select an appropriate rate taking into account varying site conditions, specification changes, market conditions, regional changes and inflation. Also it suffers from a lack of precision, and at best can only be a rather blunt tool for establishing general guidelines.

  1. Recession, Tax Cuts and Budget Deficits.

    The law was designed to cut the accumulated deficits from 1994 to 1998 by about $500 billion. In 1998, the Federal budget reported its first surplus ($69 billion) since 1969. In 1999, the surplus nearly doubled to $124 billion. As a result of these surpluses, Federal debt held by the

  2. It is often argued that buffer stock schemes should be used to control the ...

    In absence of any intervention, the market price would drop below P min. in the next year; bad production may mean that only S2 can be supplied. The market price would therefore rise above the maximum permitted by the business, and so the business sells CD of its sticks onto the market to reduce the price to P max.

  1. ASSESS THE EFFECTIVENESS OF ECONOMIC PLANNING IN BRINGING ABOUT STABILITY AND PROGRESS IN GERMANY ...

    As a result of these measures, unemployment fell dramatically, from six million in 1933 to two million in 1935, to a mere 0.1 million in 1939. However, this came at a substantial price for many people. One of the measures taken was the destruction of independent trade unions and making

  2. An Empirical Investigation into the Causes and Effects of Liquidity in Emerging

    The Expert Law website7 suggests that other companies may be looking to refinance debt, using high-yield bonds, in order to pay down lines of credit, retire older bonds or consolidate credit at attractive rates of interest. Some firms may not be able to finance all their capital needs, through bank

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work