Q1. Identify two strategies based on the fiscal and monetary policy that would encourage people to spend money in order to create economic growth.
Fiscal and monetary policies are demand side policies that can be strategically employed for realizing economic growth by motivating consumers to spend money. It can be made possible by brining an increase in aggregate demand (AD) if the economy is passing through recession or growth is below the expected level (Pettinger, 2012).
Monetary policy can be the most randomly used tool for impacting economic activity. To encourage AD, the Central Bank of a country can reduce interest rates. A reduction in interest rates leads to lowering the value of borrowing, promoting investment and peoples’ spending. When interest rates reduce, it results in discouraging trend in saving, rather creating an appeal to spend more. A cut in interest rates also brings a decrease in mortgage interest instalments, offering consumers an opportunity to spend more (Pettinger, 2012).
Monetary policy cannot be successful always in encouraging spending if a liquidity trap is created. For example, in the UK, interest rates were reduced by 0.5%in the year 2009 but people preferred to return back the bank borrowings, thus, discouraging spending. Banks were already facing cash crunch, so preferred not to lend. It indicates that theoretically it may be cost-efficient to borrow but in practicality difficult to create credit (Pettinger, 2012).
Nevertheless, the central bank of a country may follow a dynamic monetary policy to ease out from the liquidity trap. It is called quantitative easing wherein the supply of money would be increased to encourage economic activity. Thus, both quantitative easing and reduction in interest rates can lead to increase in investment and economic activity. Thus, monetary policy can be used as a dependable tool by the central government to inspire people shop around, boosting economic activity (Pettinger, 2012).
Another tool in the possession of central banks is the fiscal policy, which can be used strategically to inspire people spend more to help in boosting the economic activity. Demand for consumer goods can be created by the government by reducing tax and increasing spending of consumers’ saving. A reduction in income tax can help consumers carry more cash for spending. There will be more employment generation, leading to economic stimulus. This is expansionary fiscal policy (Pettinger, 2012).
The obstacle with expansionary fiscal policy is that it may boost government borrowing as well, as the government has to create funds to boost spending. These funds have to be arranged from the private sector (Pettinger, 2012).
Fiscal policy use is not a foolproof strategy, as it can lead to an increase in the money borrowed by the government. If economy is stable, increased government borrowing can limit the scope and space left to private sector. Nevertheless, if spending by the private sector is shrinking and the saving percentage is increasing, as given in the situation; fiscal policy tool can be a successful strategy to create demand in the market so that people spend money (Pettinger, 2012).
Q2. What do you mean by balance of payment? Elaborate with the help of suitable examples.
Balance of payment cannot remain equal although the totals of both -- payments and revenues, is supposed to be equal; inequalities are bound to occur either surplus of payments or revenue or deficits in specific type of transactions. Thus, balance of payment can be in deficit or surplus in goods trade, services trade, foreign investment revenues, unilateral money transfers, private business, the exchange of gold and money between different governments’ central banks and treasuries, or any similar type of other global transactions. The balance of payment statement of a country, either in deficit or surplus must have reference to some specific type of transactions, indicating whether it is a deficit account or surplus one. For example, we can see below in table 1 that in 2004 the United States had a deficit of $665.4 billion in commodities but a surplus of $48.8 billion in service sector (Stein, 2008).
A deficit current account of a country has such features as higher cost level, higher gross national product, higher interest rates, lower hurdles to imports, besides grassy landscape for investment opportunities, relatively to situations in other countries with comparatively better exchange rate. The impact of a shift in any of the variables cannot be foretold without analysing the impact on the other causal variables on the current account balance. For instance, if the government of a country heightens tariffs, its peoples will afford lesser imports, leading to a cut in the current account deficit. But this cut will happen in that situation only when one of the other variables shifts to initiate a reduction in the capital account surplus. If no change happens to any of the variables, the decreased imports due to an increase in tariff will lead to a reduction in the demand for foreign currency, which can result in the value shift of the U.S. dollar. If the U.S. is the country example, then an increase in the cost of the dollar will make U.S. exports costlier and imports relatively cheaper, compensating the impact of the tariff hike. It leads to the conclusion that tariff hike does not bring any shift in the balance maintained in the current account (Stein, 2008).
Q3. What are capital projects and debt services? Explain with the help of suitable examples.
When we talk about capital projects, it is related to state and local government run capital projects. It is one of the eleven types of fund entities. These capital projects are funded by the government. Resources are arranged by the government to buy-out or build key capital location. Some of the resources used by the government to buy-out include:
1) profits from long-term debt issues,
2) monetary assistance or payments from other governmental departments,
3) funds from private sector,
4) transfer of funds from other governmental entities,
5) special appraisals, and
6) other sources (Harmon, 2011).
Arrangement of funds for government capital projects can be better understood through some examples. For instance, the local government wanted to construct a building to house the fire department in the city of Aberdeen. Funds were sanctioned to the expected value of $150,000. On a specific date in the year 2008, the release of 6% bonds equalling the value of $150,000 was processed for issuance. If there was a difference between the value of the bonds and the profits from their sale, it was shifted to another fund, called debt services. The transactions related to the fire department building that materialized in the year 2008 to generate funds for the capital project, are enumerated below (Harmon, 2011).
1. Encumbrances were registered in the figures of $150,000.
2. Profits from bond release were entered into records, figuring $155,000.
3. Additional amount realized from the sale of bonds was shifted to the Debt Service Fund.
4. The developer was paid $150,000, as agreed to be paid to the builder after the finish of the construction work for the said building.
5. Contractor was paid 5% less than the total amount, as the retention amount of the contract.
6. Final contract price was paid. The nominal accounts were closed.
The journal entries would be maintained under the capital projects by entering the transactions and occurrences, such as:
For recording encumbrance to the tune of $150,000 and the same figure for the reserve of the said encumbrance.
For showing profits of $155,000 from bonds sale, both cash and bond sale profits will be shown equal.
Additional profits earned from bonds sale to the tune of $5,000 will be shown, as shifted to debt services fund in cash.
Entries for reserve of encumbrances and encumbrances will be same, i.e. $150,000. Entries for expenses and contracts payable would also be equal, i.e. $150,000.
The 5% retention money would equal to $7,500. After deducting it from the contracted amount of $150,000, the net paid cash to the contractor would be $142,500.
After paying the final amount as per the contract, nominal accounts are shut down (Harmon, 2011).
Debt Services
These are funds under the government fund categories, as resources for making payments of long-run debt of principal amount and interest. It is arranged by such sources as:
Proceeds from general property tax
Income from sales tax or some particular tax
Profits transferred from other funds
Special appraisals
Income from investment in debt services funds.
Debt services can be better explained through an example. For example, the City of Cape May sanctioned and released $200,000 of 5%, three-year term bonds on January 1, 2008. Accrued interest is paid yearly basis on December 31. A debt service fund is made to gather the required resources for making yearly interest payments on the bonds and to cash on the bonds, as the time of maturity comes to a close. The needed yearly deposit for principal and interest is shifted yearly to the debt service fund from the general class fund. There is an underlying assumption that money transferred to the debt service fund for making payment of principal can get a yearly return of 8% on investment (Harmon, 2011).
References
Harmon, Coby., 2011. ‘Ch. 18-21: Introduction to accounting for state and local government units’. Advanced Accounting. John Wiley & Sons, Inc. [Accessed 5 April 2016].
Pettinger, T., 2012. Policies for economic growth. [online] Available from: http://www.economicshelp.org/blog/5272/economics/policies-for-economic-growth/ [Accessed 5 April 2016].
Stein, H., 2008. Balance of payments. The Concise Encyclopedia of Economics. Available from: http://www.econlib.org/library/Enc/BalanceofPayments.html [Accessed 5 April 2016].
