Fiscal and Monetary Policy Fundamentals
Fiscal Policy
Discretionary: Public works, education, transfers, and tax modifications.
Automatic Stabilizers: Tax contributions.
Types of Deficit
- Cyclical Deficit: Occurs during the inevitable stages of emerging from a recession cycle. It is transient.
- Structural Deficit: A deficit that remains constant even in situations close to full employment.
Deficit Financing: Issuing public debt, raising taxes, or increasing money in circulation.
Factors Determining the Price of Money
Operating risk, loan term, and liquidity (the capacity of assets to become legal tender without losing value).
Monetary Concepts
- AAL: Other liquid assets in the hands of the public.
- Monetary Aggregate: A magnitude that brings together different kinds of money.
- Money Supply: The amount of money circulating in an economy.
Commercial banks transfer funds to customers under conditions imposed by the ECB. The market where the central bank grants liquidity facilities to commercial banks is called the interbank market.
Banking Reserves
- Fractional Reserve: The percentage of money a bank keeps to meet customer cash withdrawals.
- Legal Reserve Coefficient: The percentage of money that banking entities must keep inactive to face customer withdrawals, as mandated by the ECB.
ECB Monetary Policy
The Governing Council of the ECB specifies the monetary policy strategy developed by the European System of Central Banks (ESCB) since January 1, 1999. This strategy aims to maintain price stability.
Monetary Instruments
- Minimum Reserves Mechanism: Increases or reduces the liquidity of the banking system.
- Open Market Operations: Controls interest rates and manages the amount of money in circulation.
- Permanent Facilities: Liquidity facilities that commercial banks obtain in their own country, instrumented through loans or absorption deposits.