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Internal balance

A situation where the level of activity in an economy is consistent with a stable rate of inflation. At higher activity levels
inflation tends to rise, and at lower levels unemployment is unnecessarily high. Maintaining internal balance is one
objective of economic policy. Internal balance is contrasted with external balance, which is a situation where the
economy has a balance of payments, on current and capital account combined, which is sustainable, at least in the
medium run. Some combination of monetary and fiscal policies should allow both internal and external balance to be
maintained.

Internal balance in economics is a state in which a country maintains full employment and price level stability. It is a
function of a country's total output,

II = C (Yf - T) + I + G + CA (E x P*/P, Yf-T; Yf* - T*)

Internal balance = Consumption [determined by disposable income] + Investment + Government Spending + Current
Account (determined by the real exchange rate, disposable income of home country and disposable income of the
foreign country).

External balance signifies a condition in which the country's current account, its exports minus imports, is neither too far
in surplus nor in deficit. It is signified by a level of the current account which is consistent with the maintenance of
existing (or growing) levels of consumption, employment and national output over the long term. It is notated by

XX = CA (EP*/P, Y-T, Yf* - T*)

External balance = the right amount of surplus or deficit in the current account.

Maintaining both internal and external balances requires use of both monetary policy and fiscal policy. That is one
reason why floating exchange rates may be superior to fixed exchange rates. Under fixed exchange rates, governments
are not usually free to employ monetary policy. Under floating rates, countries can use both.

What Is the Primary Budget Balance, And Why People Use It

The primary budget balance is the government fiscal balance excluding interest payments. As an equation,

Overall Fiscal Deficit = (Primary Deficit) + (Government Interest Payments).

Alternatively,

Primary Deficit = (Non-Interest Spending) (Taxes).

The implication is that interest payments are singled out as a special category of the budget.

Breaking out interest payments appears to make sense if you are interested in modelling monetary policy - which
directly affects the level of interest payments - and are less interested in fiscal policy. This is a good description of the
motivation for the creation of most Dynamic Stochastic General Equilibrium (DSGE) models, as these models are
typically created for the use of central banks.

Within the context of many of these models, the primary budget balance is taken to be exogenous determined outside
the model. (Given that hundreds if not thousands of DSGE macro models have been churned out, there may be
exceptions to that statement.) The interest component is determined by the monetary policy rule embedded within the
model, based on the evolution of the model economy.

The standard working assumption is that the primary balance is the result of fiscal policymakers, and that they do not
wish to depart from this set policy. For example, they do not want to be forced to raise or lower taxes, as that has
political consequences. The same holds true for programme spending. The usual interpretation of holding the trajectory
of the primary balance fixed is to see whether the current fiscal policy settings are "sustainable". (In practice, fiscal
settings change regularly as the result of the political process.)

If we follow the assumption that the path of the primary budget balance has been fixed, we can then simulate what
happens to debt levels based on interest rate scenarios. A typical result is that if one sets nominal rates growing greater
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than nominal GDP growth, debt levels can spiral out of control unless primary surpluses are run (explosive debt
dynamics). As a result, this style of forecasting is an excellent way of generating scary headlines about fiscal policy. A
cynic might insinuate that is exactly why the primary surplus has been used as an analysis tool.

Problems With The Primary Budget Balance

I will now list some of the problems associated with using the primary budget balance.

Primary Budget Balance Is A Function Of Economic Activity

The basic problem is that it makes very little sense for fiscal policymakers care about the primary balance. Taxes are not
imposed in the form of absolute levels; they are almost always imposed as percentages of nominal incomes and activity
(e.g., income and sales taxes). Media discussions may refer to dollar amounts that will be raised by a tax measure, but
those dollar amounts are based on forecasts of taxable activity. As such, the tax component of the primary balance will
shift based on the economic cycle, even if policy settings are unchanged. (Note: a progressive income tax system, which
has tax rates rise as incomes increase, creates a greater sensitivity to nominal GDP than is the case for the simplified flat
tax rate used in my simulations.)

Governments have slightly more control over programme spending, but even that will break down on horizons longer
than a few years. Salaries of civil servants will presumably rise along with private sector salaries and costs of goods
procured will rise with inflation. (Or actually drive inflation, if you are a Chartalist.)

However, transfer payments such as unemployment insurance are completely dependent upon the economic cycle.
Even payments to retirees may vary according to the cycle; a weak economy could force many older workers into early
retirement. (Although what we are seeing now is that the older cohorts are being forced to work longer, and that
unemployment has been shifted towards younger workers. This is unfortunate is that these younger citizens end up
being excluded from the labour market. This is a particularly perverse outcome given the lack of workers that is allegedly
being caused by demographics.)

The net result is that the primary budget balance moves in a counter-cyclical fashion with the business cycle (deficits rise
during recessions). The usual reaction function of central banks means that interest payments generally move in the
opposite direction (they cut the policy rate during a recession). The time preference effects of an interest rate cut is
generally viewed to override the impact of lower interest income, but there is a debate over that (see this theme article
for a list of posts discussing this topic). In any event, developed market governments have a good deal of fixed coupon
debt, so that overall interest payments only follow the average of the policy rate with a lag.

Interest Spending Is A Form Of Stimulus

The second area of analytical weakness is how interest payments are dealt with. It makes sense to do a stand-alone
sensitivity analysis of an individual or firms finances with respect to interest costs. If their interest expenses rise, there
will only be a negligible impact on national GDP, so it is safe to make an all else equal assumption with regards to
interest rate scenarios. Such an assumption makes no sense for a central government; changes in its interest payments
will have a measurable impact on GDP.

Interest payments are a form of stimulus to the economy. Interest spending probably has a low short-term multiplier,
given that interest mainly flows to those with a high saving rate, but at least some of that money will be spent. As such,
increasing interest spending reduces the need for other social transfers that act to stimulate the economy.
(Demonstrating this was the point of my previous article on interest costs.)
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One could argue that the consumption function in my model was too simplistic; a proper inter-temporal optimisation
would generate different results. (See this post by Nick Edmonds which offers a summary of a recent controversy in the
blogosphere over consumption functions.) However, I am unsure whether this criticism has merit with regards to my
scenario involving a shock to interest payments.

I believe that it would be possible to generate a similar pair of scenario outcomes even if you replaced my Stock-Flow
Consistent (SFC) model with a DSGE model. The exact economic trajectory might vary slightly, but the steady state
condition that I focus on could presumably be generated by a suitably chosen set of model parameters. (It would
certainly be difficult to prove that the contrary; i.e., that there exists no model that reflects standard DSGE assumptions
that could generate a trajectory close to my simulation results.) The rise in interest rates in my model was a
permanent level shift, and would have reflected a change in the time preference parameter. As such, the change in
interest income was a permanent increase, and so this increase would be largely spent.

(If one attempted to re-create the simulation trajectories with a DSGE model, the very interesting question of Ricardian
Equivalence would come up. Given the complexities associated with Ricardian Equivalence, I will discuss it in a later
post.)

Non-Explosive Dynamics

The paper Fiscal Policy In A Stock-Flow Consistent Model, by Wynne Godley and Marc Lavoie, gives a more formal
explanation of how to approach fiscal policy using SFC models. They have a number of results within that paper, but
here is one interesting point with regards to "explosive" debt dynamics:

Our simple SFC model can, however, provide us with a more surprising result. It is usually asserted that for the debt
dynamics to remain sustainable, the real rate of interest must be lower than the real rate of growth of the economy for
a given primary budget surplus to GDP ratio. If this condition is not fulfilled, the government needs to pursue a
discretionary policy that aims to achieve a sufficiently large primary surplus. We can easily demonstrate that there are
no such requirements in a fully-consistent stock-flow model such as ours.
They additionally argue that the emphasis on monetary policy is misplaced, and that fiscal policy could theoretically
achieve the inflation and output targeting that has been currently delegated to central banks. However, that topic is well
beyond the scope of this post.

Economic stabilization :Monetary Policy, Fiscal Policy and Direct Controls

Economic stabilisation is one of the main remedies to effectively control or eliminate the periodic trade cycles which
plague capitalist economy. Economic stabilisation, it should be noted, is not merely confined to a single individual sector
of an economy but embraces all its facts. In order to ensure economic stability, a number of economic measures have to
be devised and implemented.

In modem times, a programme of economic stabilisation is usually directed towards the attainment of three objectives:
(i) controlling or moderating cyclical fluctuations; (ii) encouraging and sustaining economic growth at full employment
level; and (iii) maintaining the value of money through price stabilisation. Thus, the goal of economic stability can be
easily resolved into the twin objectives of sustained full employment and the achievement of a degree of price stability.

The following instruments are used to attain the objectives of economic stabilisation, particularly control of trade cycles,
relative price stability and attainment of economic growth:

(1) Monetary policy

(2) Fiscal policy; and

(3) Direct controls.

1. Monetary Policy:

The most commonly advocated policy of solving the problem of fluctuations is monetary policy. Monetary
policy pertains to banking and credit, availability of loans to firms and households, interest rates, public debt and its
management, and monetary management.
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However, the fundamental problem of monetary policy in relation to trade cycles is to control and regulate the volume
of credit in such a way as to attain economic stability. During a depression, credit must be expanded and during an
inflationary boom, its flow must be checked.

Monetary management is the function of the commercial banking system, and through it, its effects are primarily
exerted the economy as a whole. Monetary management directly affects the volume of cash reserves of banks, regulates
the supply of money and credit in the economy, thereby influencing the structure of interest rates and availability of
credit.

Both these factors affect the components of aggregate demand (consumption plus investment) and the flow of
expenditures in the economy. It is obvious that an expansion in bank credit causes an increasing flow of expenditure (in
terms of money) and contraction in bank credit reduces it.

In the armoury of the central bank, there are quantitative as well as qualitative weapons to control the credit- creating
activity of the banking system. They are bank rate, open market operations and reserve ratios. These are interrelated to
tools which operate on the reserves of member banks which influence the ability and willingness of the banks to expand
credit. Selective credit controls are applied to regulate the extension of credit for particular purposes.

We shall now briefly discuss the implications of these weapons.

Bank Rate Policy:

Due to various reasons, the bank rate policy is relatively an ineffective weapon of credit control. However, from the
viewpoint of contracyclical monetary policy, bank rate policy is usually interpreted as an evidence of monetary
authoritys judgement regarding the contribution of the current flow of money and bank credit to general economic
stability.

That is to say, a rise in the bank rate indicates that the central bank considers that liquidity in the banking system
possesses an inflationary potential. It implies that the flow of money and credit is very much in excess of the actual
productive capacity of the economy and therefore, a restraint on the expansion of money supply through dear money
policy is desirable.

ADVERTISEMENTS:

On the other hand, a reduction in the bank rate is generally interpreted as an evidence of a shift in the direction
of monetary policy towards a cheap and expansive money policy. A reduction in bank rate then is more significant as a
symbol of an easy money policy than anything else. However, the bank rate is most effective as an instrument of
restraint.

Effectiveness of Bank Rate Policy in Expansion:

According to Estey, the following difficulties usually arise in the way of an effective discount policy in expansion:

1. During high prosperity, the demand for credit by businessmen may be interest-inelastic.

2. The rising of bank rate and a consequent rise in the market rates of interest may attract loanable funds from the
financial intermediaries in the money market and assist in counteracting undesired effects.

3. Though the quantity of money may be controlled by the banking system, the velocity of its circulation is not directly
under the influence of banks. Banking policy may determine how much credit there should be but it is the trade which
decides how much and how fast it will be used. Thus, if the velocity of the movement is contrary to the volume of credit,
banking policy will be rendered ineffective.

4. There is also the difficulty of proper timing in the application of banking policy. Brakes must be applied at the right
time and in the right quarter. If they are applied too soon, they must bring expansion to an end with factors of
production not fully employed. And when applied too late, there might be a runaway monetary expansion and inflation,
completely out of control.

Open Market Operations:

The technique of open market operations refers to the purchase and sale of securities by the central bank. A selling
operation reduces commercial banks reserves and their lending power.

However, because of the need to maintain the government securities market, the central bank is completely free to sell
government securities when and in what amounts it wishes in order to influence commercial banks reserve position.
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Thus, when a large public debt is outstanding, by expanding the securities market, monetary policy and management of
the public debt become inseparably intertwined.

Reserve Ratios:

The monetary authorities have at their disposal another most effective way of influencing reserves and activities of
commercial banks and that weapon is a change in cash reserve ratios. Changes in the reserve ratios become effective at
a pre-announced date.

Their immediate effect is to alter the liquidity position in the banking system. When the cash reserve ratio is raised
commercial banks find their existing level of cash reserves inadequate to cover deposits and have to raise funds by
disposing liquid assets in the monetary market. The reverse will be the case when the reserve ratio is lowered. Thus,
changes in the reserve ratios can influence directly the cash volume and the lending capacity of the banks.

It appears that the bank rate policy, open market operations and changes in reserve ratios exert their influence on the
cost, volume and availability of bank reserves through reserves, on the money supply.

Selective Controls:

Selective controls or qualitative credit control is used to divert the flow of credit into and out of particular segments of
the credit market. Selective controls aim at influencing the purpose of borrowing. They regulate the extension of credit
for particular purposes. The rationale for the use of selective controls is that credit may be deemed excessive in some
sectors at a time when a general credit control would be contrary to the maintenance of economic stability.

It goes without saying that these various means of credit controls are to be co-ordinated to achieve the goal of economic
stability.

Effectiveness of Monetary Control:

Monetary policy is much more effective in curbing a boom than in helping to bring the economy out of a depressionary
state. It has long been recognised that monetary management can always contract the money supply sufficiently to end
any boom, but it has little capacity to end a contraction.

This is because the actions of monetary management do not directly enter the income-expenditure stream as the most
effective contra-cyclical weapon, for their first impact is on the asset structure of financial institutions, and in this
process of altering the assets structure, rate of interest, volume of credit and the income-expenditure flow may be
altered.

All these operate more significantly in restraining the income stream during expansion than in inducing an increase
during contraction. However, the greatest advantage of monetary policy is its flexibility. Monetary management makes
decisions about the rate of change in the money supplies that are consistent with economic stability and growth on a
judgement of given quantitative and qualitative evidences.

But, whether this point of monetary policy will prove its effectiveness or not depends on its exact timing. Manipulation
of bank rate and open market dealings by the central bank should be reasonably effective if applied quickly and
continuously in preventing booms from developing and consequently, into a depression.

To sum up, monetary policy is a necessary part of the stabilisation programme but it alone is not sufficient to achieve
the desired goal. Monetary policy, if used as a tool of economic stabilisation, in many ways, serves as a complement of
fiscal policy.

It is strong, whereas fiscal policy is weak. It is flexible and capable of quick alternations to suit the measure of pressures
of the time and needs. However, it is to be co-ordinated with fiscal policy. A wrong monetary policy may seriously
endanger and even destroy the effectiveness of fiscal policy. Thus, monetary policy and fiscal policy, each reinforcing
and supplementing the other, are the essential elements in devising an economic stabilisation programme.

2. Fiscal Policy:

Today, foremost among the techniques of stabilisation is fiscal policy. Fiscal policy as a tool of economic stability,
however, has received its due importance under the influence of Keynesian economies only since the depression years
of the 1930s.

The term fiscal policy embraces the tax and expenditure policies of the government. Thus, fiscal policy operates
through the control of government expenditures and tax receipts. It encompasses two separate but related decisions:
public expenditures and level and structure of taxes. The amount of public outlay, the inducement and effects of
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taxation and the relation between expenditure and revenue exert a significant impact upon the free enterprise
economy.

Broadly speaking, the taxation policy of the government relates to the programme of curbing private spending. The
expenditure policy, on the other hand, deals with the channels by which government spending on new goods and
services directly add to aggregate demand and indirectly income through the secondary spending which takes place on
account of the multiplier effect.

Taxation, on the other hand, operates to reduce the level of private spending (on both consumption and investment) by
reducing the disposable income and the resulting savings in the community. Hence, under the budgetary phenomenon,
public expenditure and revenue can be combined in various ways to achieve the desired stimulating or deflationary
effect on aggregate demand.

Thus, fiscal policy has quantitative as well as qualitative aspect changes in tax rates, the structure of taxation and its
incidence influence the volume and direction or private spending in economy. Similarly, changes in governments
expenditures and its structure of allocations will also have quantitative and redistributive effects on time, consumption
and aggregate demand of the community.

As a matter of fact, all government spending is an inducement to increase the aggregate demand (both volume and
components) and has an inflationary bias in the sense that it releases funds for the private economy which are then
available for use in trade and business.

Similarly, a reduction in government spending has a deflationary bias and it reduces the aggregate demand (its volume
and relative components in which the expenditure is curtailed). Thus, the composition of public expenditures and public
revenue not only help to mould the economic structure of the country but also exert certain effects on the economy.

For maximum effectiveness, fiscal policy should be planned on both long-run and short-run basis. Long- run fiscal policy
obviously is concerned with the long- run trends in government income and spendings. Within the framework of such a
long-range plan of fiscal operations, the budget can be made to vary cyclically in order to moderate the short-run
economic fluctuations.

Basically two sets of techniques can be employed for planning the desired flexibility in the relation between tax revenue
and expenditure: (1) built-in flexibility or automatic stabilisers, and (2) discretionary action.

Built -in Flexibility: The operation of a fiscal policy is always confronted with the problem of timing and forecast. A fiscal
policy administrator has always to face the question: When to do what? But it is a very difficult and complex question to
answer. Thus, in order to minimise the difficulties that arise from uncertainties of forecasting and timing of fiscal
operations, an automatic stabiliser programme is often advocated.

Automatic stabiliser programme implies that in a given framework of expenditure and revenue relation in a budgetary
policy, there exist factors which provide automatically corrective influences on movements in national income,
employment, etc. This is what is called built-in flexibility. It refers to a passive budgetary policy.

The essence of built-in flexibility is that (i) with a given set of tax rates tax yields will vary directly with national income,
and (ii) there are certain lines of government expenditures which tend to vary inversely with movements in national
income.

Thus, when the national income rises, the existing structure of taxes and expenditures tend to automatically increase
public revenue relative to expenditure, and to increase expenditures relative to revenue when the national income falls.
These changes tend to mitigate or offset inflation or depression at least partially. Thus, a progressive tax structure seems
to be the best automatic stabiliser.

Likewise, certain kinds of government expenditure schemes like unemployment compensation programmes,
government subsidies or price-support programmes also offset changes in income by varying inversely with movements
in national income.

However, automatic stabilisers are not a panacea for economic fluctuations, since they operate only as a partial offset to
changes in national income, but provide a force to reverse the direction of the change in the income.

They slow down the rate of decline in aggregate income but contain no provision for restoring income to its former
level. Thus, they should be recognised as a very useful device of fiscal operations but not the only device.
Simultaneously, there should be scope for discretionary policies as the circumstances will call for.

Discretionary Action:
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Quite often, it becomes absolutely necessary to have fiscal operations with a tool kit of discretionary policies consisting
of measures for putting into effect with a minimum delay, the changes in government expenditures. This calls for a
skeleton of public works projects providing for administrative discretion to employ them and the funds to put them into
effect.

It calls for a budgetary manipulation an active budget policy constituting flexible tax rates and expenditures. There can
be three ways of discretionary changes in tax rates and expenditures: changing expenditure with constant tax rates;
changing tax rates and constant expenditure; and a combination of changing tax rates and changing expenditures.

In general, the first method is probably superior to the second during a depression. That is to say, to increase
expenditures with the level of taxes remaining unchanged is useful in pushing up the aggregate spending and effective
demand in the economy. However, the second method will prove to be superior to the first during inflation.

That is to say, inflation could be checked effectively by increasing the tax rates with a given expenditure programme. But
it is easy to see that the third method is much more effective during inflation as well as deflation than the other two.

Inflation would, of course, be more effectively curbed when taxes are enhanced and public expenditure is also
simultaneously reduced. Similarly, during a depression, the spending rate of private economy will be quickly lifted up if
taxes are reduced simultaneously with the increasing public expenditure.

However, the main difficulty with most discretionary policies is their proper timing. Delay in discretion and
implementation will aggravate the problem and the programme may not prove to be effective in solving the problems.

Thus, many economists fear that discretionary government actions are likely to do more harm than good, owing to the
uncertainty of government actions and the political pressures to favour vested interests. That is why reliance on built-in
stabilisers, as far as possible, has been advocated.

3. Direct Controls:

Broadly speaking, direct controls are imposed by government which expressly forbid or restricts certain kinds of
investment or economic activity. Sometimes, direct government controls over prices and wages as a measure against
inflation have been advocated and implemented.

During World War II, price-wage controls were employed in conjunction with consumer rationing and materials
allocation to curb generalised total excess demand and to direct productive resources into channels desired by the
government. Monetary-fiscal controls may be used to curb excess demand in general but direct controls can be more
useful when they are applied to specific scarcity areas.

Direct controls have the following advantages:

1. They can be introduced or changed quickly and easily: hence the effects of these can be rapid.

2. Direct controls can be more discriminatory than monetary and fiscal controls.

3. There can be variation in the intensity of the operations of controls from time to time in different sectors.

In a peace-time economy, however, there are serious philosophical and political objections to direct economic controls
as a stabilisation device Objections have been raised to such controls on the following counts:

1. Direct controls suppress individual initiative and enterprise.

2. They tend to inhibit innovations, such as new techniques of production, new products etc.

3. Direct controls may breed or induce speculation which may have destabilising effects. For instance, if it is expected
that a commodity X, say steel, is to be rationed because of scarcity, people may try to hoard large stocks of it, which
aggravates its shortage. It, thus, encourages the creation of artificial scarcity through large-scale hoarding;.

4. Direct controls need a cumbersome, honest and efficient administrative organisation if they are to work effectively.

5. Gross disturbances reappear as soon as controls are removed.

In short, direct controls are to be used only in extraordinary circumstances like emergencies, but not in a peace-time
economy.

Supply Side
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The supply-side theory is an economic theory holding that bolstering an economy's ability to supply more goods is the
most effective way to stimulate economic growth.

Supply-side economics is better known to some as "Reaganomics," or the "trickle-down" policy espoused by 40th U.S.
President Ronald Reagan. He popularized the controversial idea that greater tax cuts for investors and entrepreneurs
provide incentives to save and invest, and produce economic benefits that trickle down into the overall economy. In this
article, we summarize the basic theory behind supply-side economics.

Like most economic theories, supply-side economics tries to explain both macroeconomic phenomena andbased on
these explanationsoffer policy prescriptions for stable economic growth. In general, the supply-side theory has three
pillars: tax policy, regulatory policy, and monetary policy.

However, the single idea behind all three pillars is that production (i.e. the "supply" of goods and services) is most
important in determining economic growth. The supply-side theory is typically held in stark contrast to Keynesian
theory which, among other facets, includes the idea that demand can falter, so if lagging consumer demand drags the
economy into recession, the government should intervene with fiscal and monetary stimuli.

This is the single big distinction: a pure Keynesian believes that consumers and their demand for goods and services are
key economic drivers, while a supply-sider believes that producers and their willingness to create goods and services set
the pace of economic growth.

The Argument That Supply Creates Its Own Demand

In economics, we review the supply and demand curves. The left-hand chart below illustrates a simplified
macroeconomic equilibrium: aggregate demand and aggregate supply intersect to determine overall output and price
levels. (In this example, output may be gross domestic product, and the price level may be the Consumer Price Index.)
The right-hand chart illustrates the supply-side premise: an increase in supply (i.e. production of goods and services) will
increase output and lower prices.

Increase in Supply
Starting Point
(Production)

Supply-side actually goes further and claims that demand is largely irrelevant. It says that over-production and under-
production are not sustainable phenomena. Supply-siders argue that when companies temporarily "over-produce,"
excess inventory will be created, prices will subsequently fall and consumers will increase their purchases to offset the
excess supply.

This essentially amounts to the belief in a vertical (or almost vertical) supply curve, as shown in the left-hand chart
below. In the right-hand chart, we illustrate the impact of an increase in demand: prices rise, but output doesn't change
much.

An Increase in Demand
Vertical Supply Curve
Prices Go Up
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Under such a dynamic - where the supply is vertical - the only thing that increases output (and therefore economic
growth) is increased production in the supply of goods and services as illustrated below:

Supply-Side Theory
Only an Increase in Supply (Production) Raises Output

Three Pillars

The three supply-side pillars follow from this premise. On the question of tax policy, supply-siders argue for
lower marginal tax rates. In regard to a lower marginal income tax, supply-siders believe that lower rates will induce
workers to prefer work over leisure (at the margin). In regard to lower capital-gains tax rates, they believe that lower
rates induce investors to deploy capital productively. At certain rates, a supply-sider would even argue that the
government would not lose total tax revenue because lower rates would be more than offset by a higher tax revenue
basedue to greater employment and productivity.

On the question of regulatory policy, supply-siders tend to ally with traditional political conservativesthose who would
prefer a smaller government and less intervention in the free market. This is logical because supply-sidersalthough
they may acknowledge that government can temporarily help by making purchases do not think this induced demand
can either rescue a recession or have a sustainable impact on growth.

The third pillar, monetary policy, is especially controversial. By monetary policy, we are referring to the Federal
Reserve's ability to increase or decrease the quantity of dollars in circulation (i.e. where more dollars mean more
purchases by consumers, thus creating liquidity). A Keynesian tends to think that monetary policy is an important tool
for tweaking the economy and dealing with business cycles, whereas a supply-sider does not think that monetary policy
can create economic value.

While both agree that the government has a printing press, the Keynesian believes this printing press can help solve
economic problems. But the supply-sider thinks that the government (or the Fed) is likely to create only problems with
its printing press by either (a) creating too much inflationary liquidity with expansionary monetary policy, or (b) not
sufficiently "greasing the wheels" of commerce with enough liquidity due to a tight monetary policy. A strict supply-sider
is, therefore, concerned that the Fed may inadvertently stifle growth.

What's Gold Got to Do with It?

Since supply-siders view monetary policy, not as a tool that can create economic value, but rather a variable to be
controlled, they advocate a stable monetary policy or a policy of gentle inflation tied to economic growth for
example, 3-4% growth in the money supply per year. This principle is the key to understanding why supply-siders often
advocate a return to the gold standard, which may seem strange at first glance (and most economists probably do view
this aspect as dubious). The idea is not that gold is particularly special, but rather that gold is the most obvious candidate
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as a stable "store of value." Supply-siders argue that if the U.S. were to peg the dollar to gold, the currency would be
more stable, and fewer disruptive outcomes would result from currency fluctuations.

As an investment theme, supply-side theorists say that the price of goldsince it is a relatively stable store of value
provides investors with a "leading indicator" or signal for the dollar's direction. Indeed, gold is typically viewed as an
inflation hedge. And, although the historical record is hardly perfect, gold has often given early signals about the dollar.
In the chart below, we compare the annual inflation rate in the United States (the year-to-year increase in the Consumer
Price Index) with the high-low-average price of gold. An interesting example is 1997-98 when gold started to descend
ahead of deflationary pressures (lower CPI growth) in 1998.

The Bottom Line

Supply-side economics has a colorful history. Some economists view supply-side as a useful theory. Other economists so
utterly disagree with the theory that they dismiss it as offering nothing particularly new or controversial as an updated
view of classical economics. Based on the three pillars discussed above, you can see how the supply side cannot be
separated from the political realms since it implies a reduced role for government and a less-progressive tax policy.

The IMF and the World Bank

The International Monetary Fund (IMF) and the World Bank are institutions in the United Nations system. They share
the same goal of raising living standards in their member countries. Their approaches to this goal are complementary,
with the IMF focusing on macroeconomic issues and the World Bank concentrating on long-term economic development
and poverty reduction.

What are the purposes of the Bretton Woods Institutions?

The International Monetary Fund and the World Bank were both created at an international conference convened in
Bretton Woods, New Hampshire, United States in July 1944. The goal of the conference was to establish a framework for
economic cooperation and development that would lead to a more stable and prosperous global economy. While this
goal remains central to both institutions, their work is constantly evolving in response to new economic developments
and challenges.

The IMFs mandate. The IMF promotes international monetary cooperation and provides policy advice and capacity
development support to help countries build and maintain strong economies. The IMF also makes loans and helps
countries design policy programs to solve balance of payments problems when sufficient financing on affordable terms
cannot be obtained to meet net international payments. IMF loans are short and medium term and funded mainly by
the pool of quota contributions that its members provide. IMF staff are primarily economists with wide experience in
macroeconomic and financial policies.

The World Banks mandate. The World Bank promotes long-term economic development and poverty reduction by
providing technical and financial support to help countries reform certain sectors or implement specific projectssuch
as building schools and health centers, providing water and electricity, fighting disease, and protecting the environment.
World Bank assistance is generally long term and is funded both by member country contributions and through bond
issuance. World Bank staff are often specialists on particular issues, sectors, or techniques.

Framework for cooperation

The IMF and World Bank collaborate regularly and at many levels to assist member countries and work together on
several initiatives. In 1989, the terms for their cooperation were set out in a concordat to ensure effective collaboration
in areas of shared responsibility.

High-level coordination. During the Annual Meetings of the Boards of Governors of the IMF and the World Bank,
Governors consult and present their countries views on current issues in international economics and finance. The
Boards of Governors decide how to address international economic and financial issues and set priorities for the
organizations.

A group of IMF and World Bank Governors also meet as part of the Development Committee, whose meetings coincide
with the Spring and Annual Meetings of the IMF and the World Bank. This committee was established in 1974 to advise
the two institutions on critical development issues and on the financial resources required to promote economic
development in low-income countries.
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Management consultation. The Managing Director of the IMF and the President of the World Bank meet regularly to
consult on major issues. They also issue joint statements and occasionally write joint articles, and have visited several
regions and countries together.

Staff collaboration. IMF and Bank staffs collaborate closely on country assistance and policy issues that are relevant for
both institutions. The two institutions often conduct country missions in parallel and staff participate in each others
missions. IMF assessments of a countrys general economic situation and policies provide input to the Banks
assessments of potential development projects or reforms. Similarly, Bank advice on structural and sectoral reforms is
considered by the IMF in its policy advice. The staffs of the two institutions also cooperate on the conditionality involved
in their respective lending programs.

The 2007 external review of Bank-Fund collaboration led to a Joint Management Action Plan on World Bank-IMF
Collaboration (JMAP) to further enhance the way the two institutions work together. Under the plan, Fund and Bank
country teams discuss their country-level work programs, which identify macroeconomic and sectoral issues, the
division of labor, and the work needed in the coming year. A review of Bank-Fund Collaboration underscored the
importance of these joint country team consultations in enhancing collaboration.

Reducing debt burdens. The IMF and World Bank have also worked together to reduce the external debt burdens of the
most heavily indebted poor countries under the Heavily Indebted Poor Countries (HIPC) Initiative and the Multilateral
Debt Relief Initiative (MDRI).

They continue to help low-income countries achieve their development goals without creating future debt problems.
IMF and Bank staff jointly prepare country debt sustainability analyses under the Debt Sustainability Framework
(DSF)developed by the two institutions.

Reducing poverty. In 1999, the IMF and the World Bank launched the Poverty Reduction Strategy Paper (PRSP) approach
as a key component in the process leading to debt relief under the HIPC Initiative and an important anchor
in concessional lending by the Fund and the Bank. While PRSPs continue to underpin the HIPC Initiative, the World Bank
and the IMF adopted in July 2014 and July 2015, respectively, new approaches to country engagement that no longer
requires PRSPs. The IMF streamlined its requirement for poverty reductiondocumentation for programs supported
under the Extended Credit Facility (ECF)or the Policy Support Instrument (PSI).

Setting the stage for the 2030 development agenda. Between 2004 and 2015 the IMF and the Bank jointly published the
annual Global Monitoring Report (GMR),which assessed progress towards meeting the Millennium Development Goals
(MDGs). In 2015, with the replacement of the MDGs with the Sustainable Development Goals (SDGs) under the 2030
Global Development Agenda, the IMF and the Bank have actively engaged in the global effort to support the
Development Agenda. Each institution has committed to new initiatives, within their respective remits, to support
member countries in reaching their SDGs. They are also working together to better assist the joint membership,
including by an enhanced support of stronger tax systems in developing countries.

Assessing financial stability. The IMF and the World Bank are also working together to make financial sectors in member
countries resilient and well regulated. The Financial Sector Assessment Program (FSAP) was introduced in 1999 to
identify the strengths and vulnerabilities of a country's financial system and recommend appropriate policy responses.

Resource allocation
In economics, resource allocation is the assignment of available resources to various uses. In the context of an
entire economy, resources can be allocated by various means, such as markets or central planning.
In economics, the area of public finance deals with three broad areas: macroeconomic stabilization, the distribution
of income and wealth, and the allocation of resources. Much of the study of the allocation of resources is devoted to
finding the conditions under which particular mechanisms of resource allocation lead to Pareto efficient outcomes, in
which no party's situation can be improved without hurting that of another party.

Allocation of Resources in Economics

Scientific management of resources in the line of production, distribution, exchange and consumption is called simply allocation of
resources. The allocation of resources discussed principle of right sharing of resources among competing sectors. Whatever, the type
of economy be it capitalist, socialist of mixed decision has to be made regarding allocation of resources. In a capitalist economy
decision about the allocation of resources are made through the free market price mechanism. A capitalist of free market economy
uses impersonal forces of demand and supply to decide what quantities and thereby determining the allocation of resources. The
producers in a free market economy motivated as they are by profit consideration take decisions regarding what goods are to be
produce and in what quantity by taking into account the relative prices of various goods.
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What to produce?

The first concered is rated with What to produce? How much to produce? Because resources are scarce production of all goods and

services needed by a society are beyond its capacity. It is simply not possible for any economy no how develop it might be. So, it has

to select a set among various alternatives production must meet the maximum social need. The first priority goes to the basic needs.

However, production is guided by profit and profit knows social justice. An economy should follow social efficiency while recollectiong

resources. The social norms and values should guide to maximize social satisfaction so allocation is best which satisfies the most. The

problem of what to produce and how much to produce depends on the necessity of the citizens of the country.

How much to produce?

The second question is concerned with the method of production. In some cases, labor may play a major role. It is called labor intensive

technology. In others, capital may play a major role. It is called capital intensive. Labor intensive methods creats more jobs favouring

more employment. It helps in mitigating unemployment problem. Capital intensive production goes for large volume of production. It

commends rapid growth rate. The right decision on the current state of the economy.

For whom to produce?

Production for masses or production for profit are two major choices that every economy has to decide. Basic needs of common people

cannot be ignored. Of course, the priority goes to wage goods production. In the quality is determined by the level of living standard,

which is the outcome of the development level of the economy. Therefore, as the development level of goods, higher production of

superior goods proceeds towards fetching super profits. This issue is also related with maintaining social justice. Meeting the basic

requirements of all segments of population is the main criteria of resources allocation.

Promotion of Efficiency in Economy

How to run an economy efficiently is the first concern of resource allocation. Economics efficiency is measured in additional welfare

achieved without worsening any result. It means that new reallocation of resource must not only be able to maintain the existing level

but also achieving new heights. Alternatively, reallocation may be profitable somewhere but incurring losses elsewhere. The main

objective is to increase aggregate profitability of the economy.

Balance in Economy

Another purpose of resource allocation is the maintainance of balance among different sectors of an economy. The balance between

rural and urban sectors, between home consumption and export promotion, between consumer goods and capital goods and regional

balance are the healthy signs of an economy. Investment in these different sectors are very important. How much to invest in what

sector? This is the major question, which is studied in this topic.

Allocation of resources, apportionment of productive assets among different uses. Resource allocation arises as an issue
because the resources of a society are in limited supply, whereas human wants are usually unlimited, and because any
given resource can have many alternative uses.

In free-enterprise systems, the price system is the primary mechanism through which resources are distributed among
the uses most desired by consumers. In planned economies and in the public sectors of mixed economies, the decisions
regarding resource distribution are political. Within the limits of existing technology, the aim of any
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economizing agency is to allocate resources in a manner that obtains the maximum possible output from a given
combination of resources.

Regulation is generally defined as legislation imposed by a government on individuals and private sector firms in order to
regulate and modify economic behaviors.[1] Conflict can occur between public services and commercial procedures (e.g.
maximizing profit), the interests of the people using these services (see market failure), and also the interests of those
not directly involved in transactions (externalities). Most governments, therefore, have some form of control or
regulation to manage these possible conflicts. The ideal goal of economic regulation is to ensure the delivery of a safe
and appropriate service, while not discouraging the effective functioning and development of businesses.

For example, in most countries, regulation controls the sale and consumption of alcohol and prescription drugs, as well
as the food business, provision of personal or residential care, public transport, construction, film and TV,
etc. Monopolies, especially those that are difficult to abolish (natural monopoly), are often regulated. The financial
sector is also highly regulated.

Regulation can have several elements:

Public statutes, standards, or statements of expectations.

A registration or licensing process to approve and permit the operation of a service, usually by a named organization or
person.

An inspection process or other form of ensuring standard compliance, including reporting and management of non-
compliance with these standards: where there is continued non-compliance, then

A de-licensing process through which an organization or person, if judged to be operating unsafely, is ordered to stop or
suffer a penalty.

Not all types of regulation are government-mandated, so some professional industries and corporations choose to adopt
self-regulating models. There can be internal regulation measures within a company, which work towards the mutual
benefit of all members. Often, voluntary self-regulation is imposed in order to maintain professionalism, ethics, and
industry standards.

For example, when a broker purchases a seat on the New York Stock Exchange, there are explicit rules of conduct, or
contractual and agreed-upon conditions, to which the broker must conform. The coercive regulations of the U.S.
Securities and Exchange Commission are imposed without regard for any individual's consent or dissent regarding that
particular trade. However, in a democracy, there is still collective agreement on the constraintthe body politic as a
whole agrees, through its representatives, and imposes the agreement on those participating in the regulated activity.

Other examples of voluntary compliance in structured settings include the activities of Major League Baseball, FIFA, and
the Royal Yachting Association (the UK's recognized national association for sailing). Regulation in this sense approaches
the ideal of an accepted standard of ethics for a given activity to promote the best interests of those participating as well
as the continuation of the activity itself within specified limits.

In America, throughout the 18th and 19th centuries, the government engaged in substantial regulation of the economy.
In the 18th century, the production and distribution of goods were regulated by British government ministries over the
American Colonies (see mercantilism). Subsidies were granted to agriculture, and tariffs were imposed, sparking the
American Revolution. The United States government maintained a high tariff throughout the 19th century and into the
20th century until the Reciprocal Tariff Act was passed in 1934 under the Franklin D. Roosevelt administration. However,
regulation and deregulation came in waves, with the deregulation of big business in the Gilded Age leading to President
Theodore Roosevelt's trust busting from 1901 to 1909, deregulation and Laissez-Faire economics once again in the
roaring 1920s leading to the Great Depression, and intense governmental regulation and Keynesian economics under
Franklin Roosevelt's New Deal plan. President Ronald Reagan deregulated business in the 1980s with his Reaganomics
plan.

In 1946, the U.S. Congress enacted the Administrative Procedure Act (APA), which formalized means of ensuring the
regularity of government administrative activity and its conformance with authorizing legislation. The APA established
uniform procedures for a federal agency's promulgation of regulations and adjudication of claims. The APA also sets
forth the process for judicial review of agency action.

Regulatory capture
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Regulatory capture is the process through which a regulatory agency, created to act in the public interest, instead
advances the commercial or special concerns of interest groups that dominate the industry said agency is charged with
regulating. The probability of regulatory capture is economically biased, in that vested interests in an industry have the
greatest financial stake in regulatory activity and are more likely to be motivated to influence the regulatory body than
dispersed individual consumers, each of whom has little particular incentive to try to influence regulators. Thus the
likelihood of regulatory capture is a risk to which an agency is exposed by its very nature.

Allocation

The first major function of fiscal policy is to determine exactly how funds will be allocated. This is closely related to the
issues of taxation and spending, because the allocation of funds depends upon the collection of taxes and the
government using that revenue for specific purposes. The national budget determines how funds are allocated. This
means that a specific amount of funds is set aside for purposes specifically laid out by the government. This has a direct
economic impact on the country.

Distribution

Whereas allocation determines how much will be set aside and for what purpose, the distribution function of fiscal
policy is to determine more specifically how those funds will be distributed throughout each segment of the economy.
For instance, the government might allocate $1 billion toward social welfare programs, but $100 million could be
distributed to food stamp programs, while another $250 million is distributed among low-cost housing authority
agencies. Distribution provides the specific explanation of what allocation was intended for in the first place.

Stabilization

Stabilization is another important function of fiscal policy in that the purpose of budgeting is to provide stable economic
growth. Without some restraints on spending, the economic growth of the nation could become unstable, resulting in
periods of unrestrained growth and contraction. While many might frown upon governmental restraint of growth, the
stock market crash of 1929 made it clear that unfettered growth could have serious consequences. The cyclical nature of
the market means that unrestrained growth cannot continue for an indefinite period. When growth periods end, they
are followed by contraction in the form of recessions or prolonged recessions known as depressions. Fiscal policy is
designed to anticipate and mitigate the effects of such economic lulls.

Development

The fourth major function of fiscal policy is that of development. Development seems to indicate economic growth, and
that is, in fact, its overall purpose. However, fiscal policy is far more complicated than determining how much the
government will tax citizens one year and then determining how that money will be spent. True economic growth occurs
when various projects are financed and carried out using borrowed funds. This stems from the the belief that the private
sector cannot grow the economy by itself. Instead, some government input and influence are needed. Borrowing funds
for this economic growth is one way in which the government brings about development. This economic model
developed by John Maynard Keynes has been adopted in various forms since the World War II era.