1.

a
Expansionary fiscal policy helps in increasing the aggregate demand and it would increase
the aggregate output making it equal to potential output. Expansionary fiscal policy is used
to kick-start the economy during a recession. It boosts aggregate demand, which in turn
increases output and employment in the economy. By using subsidies, transfer payments
(including welfare programs), and income tax cuts, expansionary fiscal policy puts more
money into consumers' hands to give them more purchasing power. It also reduces
unemployment by contracting public works or hiring new government workers, both of
which increase demand and spurs consumer spending, which drives the performance of the
economy. In pursuing expansionary policy, the government increases spending, reduces
taxes, or does a combination of the two. It takes one of the three forms:
• An increase in Govt. purchases
• A cut in taxes
• An increase in Govt. transfers
During the recession in US, American Recovery and Reinvestment Act cut taxes,
extended unemployment benefits, and funded public works projects. They also incurred
sending on infrastructure, research and development, transfer payments to the unemployed
etc. In 2008 George bush signed an act which provided and stimulus of 7152 billion the help
in time of recession. The act also consists of a bill which provided 600$ tax rebates to low-
and middle-income Americans.
After the Great Recession of 2008–2009 (which started, actually, in very late 2007), U.S.
government spending rose from 19.6% of GDP in 2007 to 24.6% in 2009, while tax revenues
declined from 18.5% of GDP in 2007 to 14.8% in 2009. The choice between whether to use
tax or spending tools often has a political tinge. As a general statement, conservatives and
Republicans prefer to see expansionary fiscal policy carried out by tax cuts, while liberals
and Democrats prefer that expansionary fiscal policy be implemented through spending
increases.
Reserve Bank of India Governor Shaktikanta Das has indicated that the government may
come up with some countercyclical policy measures on the fiscal side to revive growth. India
needs sector-specific measures to fight economic slowdown
• The government also allowed an additional 15 per cent depreciation on vehicles
acquired from now till March 2020.
• Changing of GST base rate from 28 per cent to 18 per cent.
• On of the announcement was the removal of the surcharge on FPI & DI profits.
• Removal of tax up to certain limit will go a long way in building trust and confidence
in the startups and the investors and shows government’s resolve towards ease of doing
business in India and encourage entrepreneurship.
1.b
An expansionary fiscal policy is a powerful tool, but a country can't maintain it indefinitely.
Eventually, its budget deficit will become too large, driving up its debt to an unsustainable
level. Therefore, this policy is typically viewed as a short-term tool, not as a constant. That's
why governments typically turn to expansionary policies during recessions and economic
slowdowns rather than during times when the economy is doing well.
According to Keynesian thinking, expansionary policy will increase output in the economy
because of an increase in aggregate demand. If the government reduces taxes, the theory
assumes that individuals and businesses will use their tax savings to buy more goods and
services. That increase in buying will stoke the economy to produce more of the goods and
services that consumes are demanding. More demand, therefore, brings about more output
and productivity.
If the government increases its spending (as opposed to lowering taxes), then the increased
demand from the government alone can be enough to prompt producers to increase their
production to meet this new demand. The theory is that it is irrelevant where the demand
comes from, so long as it is sufficiently large to stoke the increase in productivity.

After the increase in aggregate demand drives up production in the economy, the theory
predicts that the labor market will be the next beneficiary. As producers increase their
production and expand their operations to meet the new demand, they will, in theory, also
hire new workers to support their growth.
In today's economy, one criticism of this theory comes from the increasingly powerful role
technology is playing in productivity and efficiency. As the Internet, smart computers, and
cheap sensors work congruently as part of the Internet of Things, many companies are
finding ways to increase productivity without the need for major hiring initiatives. Many
attribute this to so-called "jobless recoveries." The main effect of expansionary fiscal policy
leads to the inflation where the prices of products will increase.
Expansionary Fiscal policy:
Fiscal policy is the means by which a govt. adjusts its spending levels and tax rates to
monitor and influence a nation’s economy as per the situation requirements. The influence
is of two types Expansionary and contractor.
In Expansionary fiscal policy intervention comes in the time of recession. It aims to shift the
aggregate demand to the right in graph with aggregate price level in Y-axis and Real GDP in
X-axis. Fiscal policy is made by govt. only, they do so by
• Increase in Govt. purchases
• A cut in taxes
• An increase in govt. transfers
Adverse effects:
A problem of expansionary fiscal policy is that it will lead to an increase in the size of the
govt. budget deficit. Higher borrowing will be led to financial crowding out. Larger deficits
could cause markets to fear debt default and push up interest rates on govt. debt.
Expansionary fiscal policy can also lead to inflation because of the higher demand in the
economy. The economy will be having high prices of products, the value of money will be
reduced
For ex: In 2008, the US tried to cut taxes, in theory, his lower tax should boost spending.
However, the economy was also experiencing falling house prices, lower confidence and a
shortage of credit, because of all these factors, expansionary fiscal policy was relatively
ineffective in promoting rapid economic growth.
A key issue of expansionary fiscal policy is that state of the economy. If expansionary fiscal
policy is pursued when the economy is close to full capacity, then the increase govt.
borrowing is likely to cause crowding out and/or contribute to higher inflation-but little
increase in real GDP.

2. To maintain price stability is the primary objective of the Euro system and of the single
monetary policy for which it is responsible. This is laid down in the Treaty on the Functioning
of the European Union. The euro system can also support the general economic policies in
the Union with a view to contributing to the achievement of the objectives of the Union".
These include inter alia "full employment" and "balanced economic growth.
Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer
Prices (HICP) for the euro area of below 2%."

Benefits of price stability

The objective of price stability refers to the general level of prices in the economy. It implies
avoiding both prolonged inflation and deflation. Price stability contributes to achieving high
levels of economic activity and employment by
 improving the transparency of the price mechanism. Under price stability people can
recognise changes in relative prices (i.e. prices between different goods), without being
confused by changes in the overall price level. This allows them to make well-informed
consumption and investment decisions and to allocate resources more efficiently;
 reducing inflation risk premia in interest rates (i.e. compensation creditors ask for
the risks associated with holding nominal assets). This reduces real interest rates and
increases incentives to invest
 avoiding unproductive activities to hedge against the negative impact of inflation or
deflation
 reducing distortions of inflation or deflation, which can exacerbate the distortionary
impact on economic behaviour of tax and social security systems
 preventing an arbitrary redistribution of wealth and income as a result of
unexpected inflation or deflation
 contributing to financial stability.
Basically, the monetary policy are two types:
1. Expansionary Monetary policy
2. Contractionary Monetary policy
During the recession Expansionary monetary policy should be taken in control because
which improve the recession condition
 The following things should be done to reduce the recession:
 Increase money supply
 Lower interest rates
 Higher investment spending raises income
 Increase in aggregate demand and AD curve shifts to the right
During recession, looser monetary policy may increase the AD and hence increase the
equilibrium output.
Since euro area inflation is expected to remain considerably below 2% for a prolonged
period, the ECB's Governing Council has judged that it needs to lower interest rates. The ECB
has three main interest rates on which it can act: the marginal lending facility for overnight
lending to banks, the main refinancing operations and the deposit facility. The main
refinancing rate is the rate at which banks can regularly borrow from the ECB while the
deposit rate is the rate banks receive for funds parked at the central bank. All three rates
have been lowered. To maintain a functioning money market in which commercial banks
lend to each other, these rates cannot be too close to each other. Since the deposit rate was
already at 0% and the refinancing rate at 0.25%, a cut in the refinancing rate to 0.15 %
meant the deposit rate was lowered to − 0.10 % to maintain this corridor. The cut is part of
a combination of measures designed to ensure price stability over the medium term, which
is a necessary condition for sustainable growth in the euro area. By reducing interest rates
and thus making it less attractive for people to save and more attractive to borrow, the
central bank encourages people to spend money or invest.
the European Central Bank (ECB) embarked on a new monetary policy measure: charging
interest on excess liquidity that banks held at the central bank. The move complemented a
series of other easing measures aimed at bringing inflation back to the ECB’s price stability
objective of below, but close to, two percent over the medium term.
A negative policy rate makes sense. When commercial banks are charged (rather than
remunerated) to deposit their excess liquidity at the ECB, they should be more inclined to
lend to consumers and companies. Consumers would then buy more goods, and companies
would invest in new productive capacity. Faster economic growth would help prevent
inflation from sinking too low—or even becoming negative—which is a sign of economic
malaise.
3. The causes for the high inflation in Venezuela are
• Over reliance on Oil exports: Venezuela has the world's largest oil reserves, but the
problem is that oil is the only source of major revenue for them. It makes up over
95% of Venezuela's revenue comes from its oil exports. If it doesn't sell oil, the
country doesn't have any money to spend
• Large fall in Productivity :The collapse of private investment since the end of the
1970s. Over-accumulation of capital led to declining profitability and thus
discouraged investment. While the overaccumulation argument can have some
merit in explaining the very rapid increase in private investment from the early
 1970s and its consequent collapse in the late 1970s, it cannot explain the very low
private investment levels that followed in the 1980s, 1990s and early 2000s.
• Dependency on Imports: The loss of competitiveness in non-oil sectors translated
into an increasing dependence on imports, especially of inputs of production, which
in turn has made local production dependent on the economy’s capacity to import.
• Currency Devaluation: The outbreak of the 1980s Latin American debt crisis
contributed to the development of pessimistic expectations regarding Venezuela’s
ability to repay its external debt and forced the 7 | P a g e government to devalue
the bolivar (for the first time since 1973) and introduce exchange controls with
multiple exchange rates that would remain in place until 1989. Although the
economy recovered already in 1984, the 1986 oil price collapse worsened
significantly Venezuela’s external position. Current account balance decline from a
surplus of $3.3billion to a deficit of over $2billion.
• Overvaluation of exchange rate: The IMF adjustment programme in Venezuela was
aimed to re-establish macroeconomic equilibria by restricting public expenditure,
eliminating price controls, liberalizing trade and introducing a single floating
exchange rate. As a result, in March 1989 the exchange controls were abolished and
a unique floating rate equal to the free market rate of 40 bolivars (Bs) per US dollar
was introduced, which implied another large devaluation
Among other causes, hyperinflation occurs due to episodes of war, political mismanagement
or the transition from a command economy in which the government owns the factor of
production to a market-based economy. Usually countries that undergo hyperinflation are
characterized by high levels of government debt. As a result, the value of the currency
decreases and a spiral effect takes hold, resulting in lost credibility on the currency demand
for higher wages.
The impact of hyperinflation in Venezuela are as follows:
The source of this financial breakdown, surrounded with regards to the Great Recession,
years after the improvement of the extraction of offbeat hydrocarbons in the United States,
demonstrated a large-scale monetary wonder of incredible significance for the area. China's
stoppage, an unfaltering increment in oil creation, and stable interest produced an overflow
of this asset that caused a drop-in costs of reference unrefined petroleum, West Texas
Intermediate (WTI), and Brent Crude, falling in 2014 from $100 a barrel to $50 a barrel, and
causing horrible changes in the economy of Venezuela
Under the monetary approach of the Nicolas Maduro government, more noteworthy
deficiencies happened because of the Venezuelan government's strategy of retention
United States dollars from merchants with value controls. Deficiencies happen in managed
items. Gross Domestic Product Because of the emergency, in 2015 the Venezuelan economy
contracted 5.7% and in 2016 it shrunk by 18.6% as indicated by the Venezuelan focal bank.
Venezuela has a solid reliance on oil, which produces about 96% of its fare incomes. The fall
in oil costs has happened when the South American nation faces runaway expansion and a
serious shortage of essential items.
Unemployment Because of the emergency, Venezuela endured its most noteworthy
joblessness rate in years. Because of the expansion and confiscations by the Venezuelan
government to privately owned businesses, numerous others left the nation, which thusly
expanded joblessness for those remaining.
Due to this hyperinflation social crisis like corruption, hunger, law and order are more
which lead to difficulty for Venezuelans and the government is the major drawback of
venuzuelan hyper inflation in which To assist small- and medium-sized businesses with the
wage increases, the government will pay the increased salaries for the first 90 days.
As more and more money was printed in the country, this gradually led to decrease
in the value of money. Knowingly price of basic commodities and all the goods and services
increased. This increased the cost of living in the economy. Also, Venezuela experienced rise
in murder rate, and it turned out to be the highest in the world. The country ran into
recession, and it was supported when the oil rates collapsed. As the prices increased the
price of education system also got raised simultaneously. It was so much difficult situation
for people of the country that they stopped to send their children to schools, as they could
save the money spent on the education in order to meet the future crisis. This moment was
trade-off situation for people as they couldn’t afford both, they either had to choose one
among them. This not only affected the literacy rate but also the wages of teachers.
4.
Structure of Current Account
1. Visible/Goods Account- export earnings & import payment for goods
2. Invisible Account- receipts and payments for various:
a. Non-factor Services- travel, transportation, insurance.
b. Income- investment income & compensations of employees
c. Unilateral Transfers – public & private transfers, gifts, grants, compensation, indemnities,
disaster relief aid etc.
 It contains credit and debit items.
 Credit includes merchandise exports and invisible exports.
 Debit includes merchandise imports and invisible imports.
These countries be concerned about widening CAD because of the following reasons:
• If there is current account deficit then the foreigners can have greater claim on domestic
assets.
• This is because such a deficit must be covered by borrowing from abroad. This may require
paying high interest rates.
• Large current account deficit could cause depreciation in exchange rate and cost push
inflation.
• The countries who has fixed exchange rate then it may indicate that they have become
uncompetitive because of higher inflation exports will be decreased and it can reduce
domestic demand.
Policies to reduce a current account deficit
Devaluation: This involves reducing the value of the currency against others. If there is a
devaluation of the currency, the price of imported goods increases and therefore the
quantity demanded of imports falls.
Monetary policy: Higher interest rates will increase the cost of debt and mortgage
repayments and leave people with less money to spend. Therefore, this will reduce their
consumption of imports, improving the current account.
Deflationary fiscal policy: An alternative to using monetary policy is to use fiscal policy. For
example, the government could increase income tax. This would reduce consumer
discretionary income and reduce spending on imports.
Large deficit could cause depreciation in exchange rate and cost-push inflation
Measures to improve current account balance:
Devaluation
This involves reducing the value of the currency against others. (e.g. selling pounds would
cause the value of the Pound to fall)
 If there is a devaluation of the currency, the price of imported goods increases and
therefore the quantity demanded of imports falls.
 Exports will become cheaper, and there will be an increase in the quantity of
exports.
 Therefore, assuming demand is relatively price elastic, we would expect a
devaluation to lead to an improvement in (X-M) and therefore the current account
on the balance of payments.
 However, it does depend upon the elasticity of demand for exports and imports.
devaluation will improve the balance on the current account, on the condition that the
combined elasticities of demand for imports and exports is greater than one.
Deflationary policies
These are policies aiming at reducing the growth of aggregate demand and reducing
inflation. They can include a tightening of fiscal policy or monetary policy; this will reduce
aggregate demand.
Monetary policy
Tight monetary policy involves increasing interest rates.
 Higher interest rates will increase the cost of debt and mortgage repayments and
leave people with less money to spend. Therefore, this will reduce their
consumption of imports, improving the current account.
 Also, higher interest rates will cause a fall in AD and therefore reduce economic
growth. This will reduce inflation and help to make UK exports more competitive.
 Deflationary policies will also put pressure on manufacturers to reduce costs, and
this will lead to more competitive exports, and so exports may increase in the long
run because of this effect.
Deflationary fiscal policy
  An alternative to using monetary policy is to use fiscal policy. For example, the
government could increase income tax. This would reduce consumer discretionary
income and reduce spending on imports.
 The advantage of fiscal policy is that it would not have an adverse effect on the
exchange rate. Higher income tax would also improve government finances.
 However, this policy will conflict with other macroeconomic objectives – with lower
aggregate demand (AD), growth is likely to fall causing higher unemployment. A
government is unlikely to want to risk higher unemployment just to reduce a current
account deficit.
Supply side policies
 Supply side policies can improve the competitiveness of the economy and help make
exports more attractive. This can improve the current account position, but it may
take considerable time to have an effect.
Lower wages
A policy used by many Eurozone economies facing a large current account deficit (but
unable to devalue within single currency) is to reduce wages. Lower wages will reduce costs
of production and improve competitiveness.
 However, lower wages will also lead to lower aggregate demand and could lead to
deflation and low growth.
 If the government cut public sector wages, it may have limited impact on improving
the competitiveness of exports.