Aggregate Demand And The Level Of Economic Activity Economics Essay

Aggregate Demand And The Level Of Economic Activity Economics EssayIntroduction sight of appraise income and the use of establishment salute which affect the economy is termed as pecuniary insurance insurance policy. Fiscal policy can be distinguished with the study manakin of macroeconomic policy, monetary policy, which stabilizes the economy by controlling rank of evoke and supply of money. Two major objectives of pecuniary policy are measureation and cost of presidency Transforming in the level , composition of taxation and regimen pulmonary tuberculosis can force on the following variables in an economy Aggregate learn and the level of economic activityThe pattern of resource allocationThe statistical distribution of income.Aggregate have and the level of economic activityAt a devoted time the set level and the total demand for goods and services in an economy(Y) is called aggregate demand (AD) . 1. It is the quantity of goods and services in an economy th at will be obtained at all probable price levels.2 When inventory levels are static the demand for the gross internal product of an economy is termed as aggregate demand. It is similarly called effective demand although at other times this term is differentiated. It is often quoted that the aggregate demand curve is downward sloping as at freeze off price levels a sizeabler ill-treat is demanded.Components of Aggregate demand and the level of economic activityAn aggregate demand curve is the summation of individual demand curves for different sectors of the economy. The aggregate demand is generally expressed as a linear sum of four divisible demand sources.3whereis consumption (whitethorn in like manner be known as consumer spend) = ac + bc(Y T),is Investment,is regimen spending,is Net export,is total exports, andis total imports = am + bm(Y T).The pattern of resource allocationResource allocation is generally apply to allot the resource available in an economy in an ec onomic way. How especial(a) resources are allocated among producers, and how limited goods and services are distributed among consumers , this study takes into observation the report cost, economic cost, opportunity cost, and other costs of resources and goods and services. Allotment of resources is a vital idea in economics and is related with economic effectiveness and maximization of utility.The distribution of incomeAmongst the population of a nation how the nations total economy is allocated is termed as income distribution. It has always been a major concern of economic policy and economic theory. The allocation of income betwixt the vital factors of production, land, labor and capital are considered to express income distribution.Fiscal policy is a vital factor for the economic development of a country. In Bangladesh monetary policy consists of activities, which the country carries out to attain and utilize resources to afford services while ensuring optimal efficiency of the economic units. This policy controls the behavior of economic forces passim the public finance. The main factors to attain these goals are variation in public ingestion, variation in public receipts, and management of public debt. These are revealed in the fiscal planning opeproportionns of the government, set up and executed on year-on-year basis.Literature ReviewFor the overall economic development of a country fiscal policy and its management exert greater influence on economic activity. To boost up an economic infrastructure many research and study have been through by economists and policymakers. In this section literature abounds on the effectiveness and importance of fiscal policy in developed and underdeveloped countries of the world.Developing countries are approach dual challenges while chthonian winning fiscal adjustment policies. One arises from the increasing demand for public expenditures forInfrastructure and social sector enthronisation, and the other ar ises from the lack of readinessto raise gross from internal sources to finance the change magnitude expenditure, primarilydue to narrow tax base. To boost competitive capacity of the country in a rapidly globalizing world, the governments of developing countries have to invest a large portion of their tax tax revenue in building forcible infrastructures. In addition, the low incomedeveloping countries in addition need to spend a major portion of their developmentexpenditures in providing social services to the poor such as health, education etc. Onthe other hand, as Khattry (2003 402) pointed out, the structural characteristics of lowincome countries, have with prevalence of unsophisticated tax administ symmetryn limit their ability to raise taxes from domestic sources, namely income and domestic verifyingtaxes. Also, the existence of a large informal sector and the underground economyconstrains the governments capacity for revenue emergence.Another source of fiscal proble m arises with the lick of trade liberalization thatrequires reduction of taxes on world-wide trade together with the elimination ofquantitative restrictions and other forms of trade barriers. at that placefore countries have toresort to domestic sources to compensate the revenue loss emanating from tradeliberalization. As the scope of domestic sources of revenue is limited due to the narrowtax base and structural constraints in the low income countries, this may lead to avulnerable fiscal position. In principle, a well functioning VAT organization on importcombined with broad based low responsibilitys) can recoup some of the revenue loss due to the greater inflow of imports that eventually follows trade liberalization. issue schema for Accelerated Poverty Reduction (NSAPR) of Bangladesh (2005) recognizes that, asgovernment revenue is heavily dependent on trade taxes, and tariff liberalizationtypically results in tariff revenue loss, alternative sources of revenue must be ensur ed inorder to prevent a sudden rise in budget deficit (which is already high). In order torecoup revenue losses due to tariff liberalization government is trying to increaserevenue from direct taxes. It is also envisaged that indirect taxes such as VAT andsupplementary duty are applied uniformly on both domestic production and imports, itwould both reduce anti-export influence and increase government revenue by widening thetax-net (NSAPR, 2005, p.86).Trade liberalization may thus lead to a fiscal squeeze as a result of re duced revenueand simultaneous increase in expenditure. According to Khattry (2003) fiscal squeezeled some countries to reduce expenditure on natural capital, while that on socialservices (e.g. health and education) has been financed by acquiring additional debt. However, it has been empirically substantiated that government capital expenditure plays an important role in enhancing economic growth. Bose et al (2003) investigated apanel of thirty developing countri es over the decades of 1970s and 1980s, and foundthat, the share of government capital expenditure in gross domestic product is validatoryly and concentrateificantlycorrelated with economic growth though flow rate expenditure is insignificant.The purpose of this paper is to evaluate the relationship amid revenue andexpenditure and its implication for managing the budget deficit. In order to do this athree variable model is formulated comprising government expenditure, revenue andgross domestic product. Firstly, existence of a long relationship among these three variables is testedby using Johansen (1991, 1995) co integration approach. Granger causality test isapplied on the corresponding vector break correction model to examine short-run causalrelationship between the variables The goal of fiscal policy is to enhance economic growth and employment and to drivestability in economic outcome variables such as the real GDP growth rate. Under the above circumstances, the nature an d objectives of fiscal policy may differ with the level of development of the countries. Long run outcome of expansionary fiscal policy depends on the nature of distribution of public resources as the same amount of public money can generate different growth pay-offs in different sectors, and the overall growth of the economy depends on the combined growth of these sectors When the government takes expansionary fiscal policy (expenditure surpassing revenue) either through increasing expenditure or reducing taxes or both, it has to borrow from internal and external sources to finance the deficit. The pattern of deficitbudget was popularized by Keynes and his fol disappoints -the principal argument is thatgovernment can boost up economic growth by increasing government expenditures inthe short run. Again the government has to shrink its expenditures during the time of growth as excessive aggregate demand can generate ostentatiousness. In hostile to the above theory some economists argue that budget deficit negatively affects economic growth According to the advocates of the latter view, lowering budget deficit reduces interest rate at that placeby increasing enthronization, which in turn enhances economic growth The risk of expansionary fiscal policy is that, it leads to public debt growth, where it is envisaged that the growth of the economy will be significant enough in the subsequent periods so that the government will have a larger revenue base to finance its enhanced debt obligations. However, mishap to generate enough economic growth may force the government into a deficit trap. Therefore the government has to borrow again to finance its deficit -this time may be in greater volume due to increase in the expenditure for repaying principal and interest of prior periods debt even if the order of magnitude of public sector activities remains unaltered. There is also a risk that, government borrowing from domestic sources may crowd out private investing by raising the rate of interest. Constraining private investment in this fashion and expending the same amount of money in less rich sectors of the economy can negatively affect overall growth of the economy. As mentioned by Carneiro et al (2004, p.9), if economic agents are non Recording due to credit constraints and lapping generation, public deficit can have a negative impact on growth as public deficits can hamper growth by competing with private physical capital for individual savings. Conversely, in developing countries public investment can be influential to crowd in private investment as depictn by Binswanger et al (1993) infrastructure accessibility and the rural banks are crucial factors for increasing private investment in agriculture, which requires substantial government interposition in facilitating private investment. Given excess liquidity in the system (as it is the case inBangladesh), in spite of significant public borrowing from the banking system over the la st 4-6 months, private credit actually proceeded at its usual tone. This however need not be true all the time.Bangladeshs fiscal policy is closely linked to its monetary policy because public budget deficits are primarily financed by increases in money supply. Theoretically, expansionary fiscal policy would generate an change magnitude supply of high-powered money in the face of frequent adjustment in the budget deficit and can provoke price spiral if there is no excess capacity in the economy (Friedman 1956 Friedman and Kuttner 1992). However, increasing government borrowing from central bank is seen as highly inflationary in the case of Bangladesh. But it should be noted that under the situation of chronic slow down of general demand (i.e. a general glut in the economy) high public expenditure can create higher(prenominal) economic activity by protecting the falling slue in demand which is financed by increased public borrowing (Kiguel 1989). However, there is a general conse nsus among economists and policy-makers that regulating the growth of money stock is necessary to achieve a jollyy stable price level and full employment of an economy (Sims 1972)Blanchard and Perotti (2002) use information just almost the elasticity of fiscal variables to identify the automatic response of fiscal policy, and find that expansionary fiscal shocks increase output, have a positive effect on private consumption, and a negative impact on private investment. More recently, using sign restrictions on the impulse-response functions and identifying the unexpected variation in government spending by a positive response of expenditure for up to four quarters after the shock, Mountford and Uhlig(2005) find a negative effect in residential and non-residential investment Similar studies applied to other countries are relatively scarce, largely due to the limited availability of quarterly public finance data, and, in addition, do not provide a consensual view. Perotti (2004) in vestigates the effects of fiscal policy in Australia Canada, Germany and the U.K., and finds a relatively large positive effect on private consumption and no response of private investment. Biau and Girard (2005) find a cumulative multiplier of government spending larger than one, and positive reactions of private consumption and private investment in France. De Castro and Hernndez de Cos2006) use data for Spain and show that, while there is a positive relationship between government expenditure and output in the short-term, in the medium and long-term expansionary spending shocks only lead to higher inflation and lower output. Heppke- Falk et al. (2006) use cash data for Germany, and find that a positive shock in government spending increases output and private consumption, although the effect is relatively small. Giordano et al. (2007) show that, in Italy, government expenditure has positive and persistent effects on output and on private consumption.AnalysisThe Peoples Republic o f Bangladesh, state of southern Asia, in the northeastern portion of the Indian subcontinent, edged on the north, east and west by India, on the southeast by Burma (Myanmar), and on the south by the speak of Bengal. The total area of the country is 147,570 sq km with a population of 126 million. It lies roughly between 2034 and 2636 North latitude and between 8801 and 9241 east longitude. The capital and leading city of Bangladesh is Dhaka. The economy of Bangladesh is comprised by that of a developing country. Its per capita income in 2008 was est. US$1,500 (adjusted by purchasing power parity) significantly lower than India, Pakistan, both which are also lesser than the world average of $10,497. According to the gradation by the International Monetary Fund, Bangladesh ranked as the 48th largest economy in the world in 2008, with a gross domestic product of US$224.889 billion. The economy has grown at the rate of 6-7% p.a. over the past few geezerhood. More than half of the GDP belongs to the service sector n betimes half of Bangladeshis are employed in the agriculture sector, with RMG, fish, vegetables, lather and leather goods, ceramics, rice as other essential produce. The aim of the governments fiscal management is striking a weighing balance between government revenue and expenditure. One more foremost goal is to uphold shortage in the existing budget as a lot as reasonable for advanced investment in the public division. As a result of cautious fiscal policy and strengthening of fiscal management, overall fiscal deficiency through the current decade remained unchanged.To formulate and execute sound fiscal policy is one of the most significant functions of the government. It puts importance on sustaining macroeconomic constancy through reconciliation public expenditure management. There is no substitute to sound fiscal management in overall economic governance as a fair public income and expenditure management that assures private sector institution s and individuals a steady macroeconomic background. The vital source of government revenue is tax. Public revenue mainly consists of direct and indirect taxes which accounted for more than 80 per centum of total government revenue. The government collects the rest of the public revenue from different non-tax collection such as fee, charge, toll etc. The level of revenue assortment is a vital indicator to establish the step of economic development of a country. The economy of a country becomes more stable if it collects large amount of revenue.In this section we are going to analyze the fiscal frame of Bangladesh during the time period from FY-1991 to FY-2008.During these years Prudent fiscal management emerged as a most important challenge facing the country. The Governments revenue mobilization efforts developed remarkably in the early 1990s following the launch of some major fiscal reforms, mainly introduction of the value-added tax (VAT) in 1991.The VAT provided greater insur ance coverage and raised rank than the taxes that it restored (mostly excise duty). The revenue tax to GDP ratio rose from 5.9 percent in FY1991 to 7.3 percent in FY1993, but since then, the proportion has remained steady at about 7 percent. A stagnant tax to GDP ratio reveals lack of improvement in broadening the tax net and in improving the tax management system in brief, the effectiveness of tax assortment remains fragile and futile. Specifically, the Government has failed to widen the coverage of direct taxes, broaden VAT coverage to high-revenue-yielding trades and services, develop the implementation of import taxes, and bolster tax government. Conversely, nontax revenues are relatively small (a bit less than 2 percent of GDP), and they also festered over much of the 1990s. As consequence, since FY1993, the entire revenue to GDP ratio has altered around 9 percent, making revenue collection of Bangladesh effort one of the weakest in the global economy.In spite of unsatisfactor y revenue collection efforts for much of the 1990s, the Government was adequate to(p) to uphold the fiscal shortage within 4-5 percent of GDP by keeping spending under control. Government expenditure, both current and capital increased rapidly. Therefore, the fiscal scarcity went up to indefensible levels. With declining alternatives to foreign investment trusting of the deficit, the Government had been compelled to finance the shortfall from domestic sources -from banking sector and domestic borrowing. The ensuing monetary adjustment seriously damaged macroeconomic stability. postpone 4 Selected Fiscal Indicators(Percent of unrefined Domestic Product)Because of drop of the revenue to GDP ratio to 9 percent in FY1998-99 from 9.3 percent in FY1997-98, caused by flood-induced disruptions, the Government attempted to reverse the declining trend and projected revenue to GDP ratio of 10 percent in the FY1999-00 budget. In spite of establishing a verified revenue mobilization object, n o major efforts were made to apply vital fiscal reforms, reduce the tax structure, strengthen tax management, and extend the tax foundation. Moreover, the hindrance in introducing the reshipment assessment scheme, and slothful growth in imports also added to revenue shortfall. Customs duties collection declined by 10 percent in FY1999-00 compared with FY1998-99, and the share of customs duties in National Board of tax revenue portion of taxes declined to 28 percent from 32 percent. Nontax revenue collection was also less than projected due mainly to reduced profit and dividend earnings of state-owned enterprises (SOEs). In FY1999-00, losses of nonfinancial SOEs were estimated at Tk31 billion, or 1.3 percent of GDP. Therefore, actual revenue mobilization in FY1999-00 rotated to be considerably below budget projections, at 8.9 percent of GDP. Government expenditure increased to 13.8 percent of GDP in FY1999-00 from 13.3 percent in FY1998-99, because of a rush in the outlay resulting from flood-induced expenditure, particularly the necessary for extra imports of food grains and post flood rehabilitation outlays. The tendency prolonged in FY1999-00 with overall expenses rising to 15 percent of GDP. Though the Government was capable to Keep up current spending at 7.6 percent of GDP (the same percentage as in the previous year), spending under the annual development program (ADP) went up to 6.7 percent of GDP from5.6 percent in FY1998-99. In the FY1999-00 budget, the Governments aim was to reduce expenses to 7.4 percent of GDP. It was a determined aim in view of the coming general election (scheduled for October 2001) when the pressures on the Government to accommodate increased expenditure is bound to be considerable.Allocation for the ADP in the FY2000-01 budget was 6.5 percent of GDP, 50 percent of which was expected to be financed from domestic resources, and 40 percent of the domestic funding of the ADP would be from bank borrowing. The choice to fund a supe rior development budget with substantial borrowing from banks had risks to sustain macroeconomic constancy. While 34 percent of the ADP funds have been allocated to sectors that goal scantness directly, about 33 percent had been assigned to infrastructure development comprising energy, transport, and communication. Not all ADP projects could be justified on grounds of accelerating the pace of development several projects had questionable merit. What was more worrying was that some low -priority projects were being financed by high-cost foreign suppliers credits. In FY 1999-00, revenue/GDP ratio was 8.47 percent, which step by step went up to 10.79 percent in FY2005-06. In FY 2007-08 the revenue/GDP more went up to 11.17 percent and the growing trend of revenue-GDP ratio raise increased to 11.24 percent in FY2008-09.Table 4.1 illustrates tax and non-tax revenue receipts and tax-GDP ratio within the period from FY1999-00 to FY2008-09.From the beginning of the FY2008-09 the revenue objectives of fiscal year came under challenge because of the impact of worldwide financial crisis. The international economy plunged into collapse mainly for noxious credit crisis in the US financial organizations and gigantic move in prices of commodities like fuel, fertilizer etc. This price drop caused poorer collection of import duties which is the largest source of revenue although the price of commodities favored reduction of high inflation condition. The assortment of import duty in FY 2008-09 fell tiny of the goals as the import duty is established on the basis of prices of the imported commodities. Study of revenue collection activities for FY2008-09 by categories illustrates that the volume of revenue collection attains from value added tax (VAT).Income tax takes up the second position in the row. Next places are held by import duties, complementary duty, additional taxes and excise duty. On the whole, the part of VAT in the entire revenue collection is progressively in creasing. It can be states that, income tax occupies second place above import duties for the second consecutive time.In FY 2008-09, though the entire revenue collection by NBR source fell diminutive of the goals but overall revenue collection stood at TK. 52525.61 crore, which is TK. 5236.49 crore higher than the assortment of the previous fiscal year showing an 11.07 percent increase. In FY 2007-08, total revenue collection placed at TK. 47289.12 crore, which was Tk. 10,069.8 crore or27.06 percent higher than the assortment of the previous year. In FY 2006-07, the total revenue collection under NBR amounted to Tk. 37219.32 crore which was Tk. 3,216.89 crore or 9.46 percent higher than that of the previous year. Item-wise tax collection from FY2006-07 to FY2008-09 is shown in Table 4.2.Management of public expenditure is the most vital part for the fiscal management of the government. The major aims of fiscal management are to uphold social safety net activities, inspire expenditur e in productive level, practice austerity in public expenditure and controls over unproductive expenses. Reducing poverty through improving the standards of living of the generals, building physical infrastructure and developing human resources are the get wind features of large public outlays in every year. Total public expenditure, development expenditure and expenditure/GDP ratio for FY 2008-09 and during the last decade are shown in Table 4.3.Investigation of entire non-development expenditure illustrates that in FY 2003-04, expenditure on pay and allowances was 27.4 percent of total non-development expenses. In FY 2004-05 and FY 2005-06 these percentage decreased to 25.3 and 27.6 respectively, but went up to 28.5 percent in FY 2006-07 and again decreased to 23.6 percent in FY 2008-09. In FY 2003-04, the spending on subsidy and current transfer accounted for 28.4 percent of entire non-development expenses. In FY 2004-05, FY 2005-06, FY 2006-07 and FY 2008-09 the spending on sub sidy and current transfer accounted for 30.1, 29.1, 31.4 and 40.5 percent of entire non-development expenses correspondingly. In FY 2004-05, FY 2005-06, FY2006-07 and FY 2008-09 the shares of interest payments on foreign and domestic credits in total non-development cost were 18.8, 19.8, 20.2 and 20.8 percent respectively.The average genuine cost against the adjusted parceling of ADP was around 90 percent during the time from 1999-00 to 2005-06 (Table 4.4). In FY2006-07 and FY 2007-08, the utilization of ADP is about 83 and 82 percent correspondingly. In FY 2008-09 the short-term expenditure records 85.7 percent utilization of revised allotment.The growing tendency of distribution and expenditure in socio-economic and physical infrastructure segments all the way through ADP is constant with the twin objectives of the government- attaining higher growth and diminishing poverty. ADP expenditure and its composition by key sectors are shown in Table 4.5.Budget is organized in line with the national plans and policies taken up for economic development, poverty diminution and social growth. There arises a budget shortage occurring from a space between the government revenue and expenditure, where expenditure becomes more important than the revenue income. The succeeding governments are taking policies to control resources and shifts earnings at an increased rate to the poor people of the country since over 40 percent of population live beneath poverty line. Though, this enhances budget shortage little further, but it generates purchasing power of a vast population that finally propel growth by escalating aggregate demand. It also facilitates a huge portion of the population to keep minimum livelihood. The tendency of budget shortage in Bangladesh obviously shows that shortage remains under 5 percent of GDP draw off for those years when there were natural catastrophies. Table 4.6 below represents data on budget shortage and the form of its financial backing passi m the time period from FY1999-00 to FY2008-09.At present the debit obligation of the government is at a reasonable stage. Financing throughout grant and credit from out sources is progressively tightening because of shifting in the policies of contributors. This, prompted the government to take a variety of restructuring initiatives and to adopt inspirational measures to mobilize resources from domestic sources together with from external sources. In principle, the government has a preferences on concessional foreign borrowing to domestic borrowing due to the poorer outlays of foreign borrowing and longer reimbursement time period.FindingsBangladesh is a third worlds developing country. At present it is going through a financial crisis. To analyze any countrys financial condition the key factor is to investigate its fiscal policy and management as fiscal policy has a great impact on the countrys development procedure. In our term paper we have discussed the fiscal condition of Bang ladesh in brief.Financing of regular insufficiency, generally undertaken through borrowings from abroad, from Bangladesh Bank, and from scheduled banks, has become a central characteristic of the fiscal policy of the country. Opportunity of borrowing from the public by the government for financing budget deficiency is very limited in the country as investments capability of the people is very low. Therefore, the opportunity of non-inflationary financing of budget shortfall does not exist here. Availability of foreign borrowing depends on the international liquidity situation and the prevailing circumstances in the international capital market, which is always uncertain and unpredictable for a country like Bangladesh.Here, some major key findings which has a great influence on Bangladeshi economy that we noted out from the analysis section are added Introduction of Value Added Tax (VAT) in early 1990s is one of the key fiscal reforms to develop a effective fiscal administration. The revenue tax to GDP ratio rose from 5.9 percent in FY1991 to 7.3 percent in FY1993 Because of drop of the revenue to GDP ratio to 9 percent in FY1998-99 from 9.3 percent in FY1997-98, caused by flood-induced disruptions, the Government attempted to reverse the declining trend and projected revenue to GDP ratio of 10 percent in the FY1999-00 budget Customs duties collection declined by 10 percent in FY1999-00 compared with FY1998-99, and the share of customs duties in National Board of Revenue portion of taxes declined to 28 percent from 32 percent In FY1999-00, losses of nonfinancial SOEs were estimated at Tk31 billion, or 1.3 percent of GDP. Therefore, actual revenue mobilization in FY1999-00 rotated to be considerably below budget projections, at 8.9 percent of GDP In FY1998-99 there had a rush in the outlay resulting from flood-induced expenditure, particularly the requirement for extra imports of food grains and post flood rehabilitation expenses In the FY1999-00 budget, the Gov ernments aim was to reduce expenses to 7.4 percent of GDP. It was a determined aim in view of the coming general election (scheduled for October 2001) when the pressures on the Government to accommodate increased expenditure is bound to be considerable. In FY 1999-00revenue/GDP ratio was 8.47 percent, which step by step went up to 10.79 percent in FY2005-06. In FY 2007-08 the revenue/GDP more went up to 11.17 percent and the growing trend of revenue-GDP ratio further increased to 11.24 percent in FY2008-09. From the beginning of the FY2008-09 the revenue objectives of fiscal year came under challenge because of the impact of worldwide financial crisis. In FY 2008-09, though the entire revenue collection by NBR source fell diminutive of the goals but overall revenue collection stood at TK. 52525.61 crore, which is TK. 5236.49 crore higher than the assortment of the previous fiscal year showing an 11.07 percent increase. In FY 2007-08, total revenue collection placed at TK. 47289.12 c rore, which was Tk. 10,069.8 crore or27.06 percent higher than the assortment of the previous year. In FY 2006-07, the total revenue collection under NBR amounted to Tk. 37219.32 crore which was Tk. 3,216.89 crore or 9.46 percent higher than that of the previous year. Item-wise tax collection from FY2006-07 to FY2008-09 The average genuine cost against the adjusted allotment of ADP was around 90 percent during the time from 1999-00 to 2005-06. In FY2006-07 and FY 2007-08, the utilization of ADP is about 83 and 82 percent correspondingly. In FY 2008-09 the short-term expenditure records 85.7 percent utilization of revised allotment. The tendency of budget shortage in Bangladesh obviously shows that shortage remains under 5 percent of GDP except for those years when there were natural catastrophes.The findings