Globalization-Snake in the Tunnel-Deficit Financing-Excess Liquidity-Primary Dealer-Capital Adequacy-Risk-Weighted Asset etc.
Bankers Of the Article
Globalization-Snake in the Tunnel-Deficit Financing-Excess Liquidity-Primary Dealer-Capital Adequacy-Risk-Weighted Asset etc.
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Globalization
Globalization is the process of international integration arising from the interchange of world views, products, ideas, and other aspects of culture. Put in simple terms, globalization refers to processes that promote worldwide exchanges of national and cultural resources. Advances in transportation and telecommunications infrastructure, including the rise of the Internet are major factors in globalization, generating further interdependence of economic and cultural activities.
The International Monetary Fund (IMF) identified four basic aspects of globalization:
1. Trade and transactions,
2. Capital and investment movements,
3. Migration and movement of people and
4. Dissemination of knowledge. Further, environmental challenges such as climate change, cross-boundary water and air pollution, and over fishing of the ocean are linked with globalization. Globalizing processes affect and are affected by business and work organization, economics, socio-cultural resources, and the natural environment. Globalization is the process of world shrinkage, of distances getting shorter, things moving closer. It pertains to the increasing ease with which somebody on one side of the world can interact, to mutual benefit, with somebody on the other side of the world.
Snake in the Tunnel
The snake in the tunnel was the first attempt at European monetary cooperation in the 1970s, aiming at limiting fluctuations between different European currencies. It was an attempt at creating a single currency band for the European Economic Community (EEC), essentially pegging all the EEC currencies to one another. With the failure of the Bretton Woods system with the Nixon shock in 1971, the Smithsonian agreement set bands of plus/minus 2.25% for currencies to move relative to their central rate against the US dollar.
This provided a tunnel in which European currencies to trade. However, in practice it implied larger bands in which they could move against each other. The tunnel collapsed in 1973 when the US dollar floated freely. The snake proved unsustainable, with several currencies leaving and in some cases rejoining. By 1977, it had become a Deutsche Mark zone with just the Belgian and Luxembourg franc, the Dutch guilder and the Danish krone tracking it. The Werner plan was abandoned.
Deficit Financing
Deficit financing, practice in which a government spends more money than it receives as revenue, the difference being made up by borrowing or minting new funds in order to increase economic activity and reduce unemployment. This is also called compensatory finance pump priming. Although budget deficits may occur for numerous reasons, the term usually refers to a conscious attempt to stimulate the economy by lowering tax rates or increasing government expenditures.
The influence of government deficits upon a national economy may be very great. It is widely believed that a budget balanced over the span of a business cycle should replace the old ideal of an annually balanced budget. Some economists have abandoned the balanced budget concept entirely, considering it inadequate as a criterion of public policy. Deficit financing, however, may also result from government inefficiency, reflecting widespread tax evasion or wasteful spending rather than the operation of a planned countercyclical policy. Where capital markets are undeveloped, deficit financing may place the government in debt to foreign creditors. In addition, in many less-developed countries, budget surpluses may be desirable in themselves as a way of encouraging private saving. Critics of deficit financing regularly denounce it as an example of shortsighted government policy. Advocates argue that it can be used successfully in response to a recession or depression, proposing that the ideal of an annually balanced budget should give way to that of a budget balanced over the span of a business cycle.
Excess Liquidity
Liquidity may describe the ease with which an asset can be sold or bought or a business ability to meet its payment obligations. In our context liquidity refers to the amount of money commercial banks hold in their reserves to meet the depositor’s requirements of withdrawals on demand. Excess liquidity therefore means that commercial banks are holding more cash reserves than they ideally should, above the usual requirement. This means that commercial banks are have more cash in holding than the customer would desire.
With higher cash reserves comes higher money supply, banks have more money to lend to one another and to customers. The lending between banks is determined by the interbank rate, which if you have been following the news, has been falling over the last few days. We can hypothesize that since the banks have higher cash reserves they can lend it to one another at a lower rate as it is in plenty. The CBK on the other hand sees this as an undesirable situation. Lower interbank rates mean that banks can borrow cheaper and lend cheaper increasing the supply of money within the money markets. An increase in money supply is one of the factors that lead to inflation.
Primary Dealer
A pre-approved bank, broker/dealer or other financial institution that is able to make business deals with the U.S. Federal Reserve, such as underwriting new government debt. These dealers must meet certain liquidity and quality requirements as well as provide a valuable flow of information to the Fed about the state of the worldwide markets. A primary dealer is a firm which buys government securities directly from a government with the intention of reselling them to others, thus acting as a market maker of government securities. The government may regulate the behavior and numbers of its primary dealers and impose conditions of entry. Some governments sell their securities only to primary dealers, some sell them to others as well.
Governments that use primary dealers include Canada, France, Italy, Spain, the United Kingdom, and the United States. These primary dealers which all bid for government contacts competitively, purchase the majority of Treasuries at auction and then redistribute them to their clients, creating the initial market in the process.
Capital Adequacy
Percentage ratio of a financial institution’s primary capital to its assets (loans and investments), used as a measure of its financial strength and stability. According to the Capital Adequacy Standard set by Bank for International Settlements (BIS), banks must have a primary capital base. Regulators try to ensure that banks and other financial institutions have sufficient capital to keep them out of difficulty. This not only protects depositors, but also the wider economy, because the failure of a big bank has extensive knock-on effects.
The risk of knock-on effects that have repercussions at the level of the entire financial sector is called systemic risk. Capital adequacy requirements have existed for a long time, but the two most important are those specified by the Basel committee of the Bank for International Settlements. This new capital framework consists of three pillars: minimum capital requirements, a supervisory review process, and effective use of market discipline.
With regard to minimum capital requirements, the Committee recognizes that a modified version of the existing Accord should remain the “standardized” approach, but that for some sophisticated banks use of internal credit ratings and, at a later stage, portfolio models could contribute to a more accurate assessment of a bank’s capital requirement in relation to its particular risk profile. It is also proposed that the Accord’s scope of application be extended, so that it fully captures the risks in a banking group.
Risk-Weighted Asset
Risk-weighted asset is a bank’s assets or off-balance sheet exposures, weighted according to risk. This sort of asset calculation is used in determining the capital requirement or Capital Adequacy Ratio (CAR) for a financial institution. In the Basel I accord published by the Basel Committee on Banking Supervision, the Committee explains why using a risk-weight approach is the preferred methodology which banks should adopt for capital calculation.
• it provides an easier approach to compare banks across different geographies
• off-balance-sheet exposures can be easily included in capital adequacy calculations
• banks are not deterred from carrying low risk liquid assets in their books Usually, different classes of assets have different risk weights associated with them. The calculation of risk weights is dependent on whether the bank has adopted the standardized or IRB approach under the Basel II framework. Some assets, such as debentures, are assigned a higher risk than others, such as cash or government securities/bonds. Since different types of assets have different risk profiles, weighing assets based on the level of risk associated with them primarily adjusts for assets that are less risky by allowing banks to discount lowerrisk assets. In the most basic application, government debt is allowed a 0% “risk weighting” – that is, they are subtracted from total assets for purposes of calculating the CAR.
For banks, risk-weighted assets are assets with special risks, especially loans to customers and other financial institutions or governments, weighted according to different levels of possible default. As risk is calculated differently for each type of loan, Basel II set out a procedure of determining the different risk levels. For example, government bonds with a rating over AA – are weighted as zero percent, whereas corporate loans with the same ratings are weighted at twenty percent. These rules also take into account the credit risk, operational risk and market risk of the loans. Other factors must be considered as well when determining risk. For example, a loan secured by a letter of credit would be weighted as riskier than one secured by collateral.
Capital Requirement
Capital requirement (also known as Regulatory capital or Capital adequacy) is the amount of capital a bank or other financial institution has to hold by its financial regulator. This is in the context of fractional reserve banking and is usually expressed as a capital adequacy ratio of liquid assets that must be held compared to the amount of money that is lent out. These requirements are put into place to ensure that these institutions are not participating or holding investments that increase the risk of default and that they have enough capital to sustain operating losses while still honoring withdrawals. Tier 1 capital Tier 1 capital is the core measure of a bank’s financial strength from a regulator’s point of view.
It is composed of core capital which consists primarily of common stock and disclosed reserves (or retained earnings), but may also include non-redeemable non-cumulative preferred stock. The Basel Committee also observed that banks have used innovative instruments over the years to generate Tier 1 capital; these are subject to stringent conditions and are limited to a maximum of 15% of total Tier 1 capital. Each country’s banking regulator, however, has some discretion over how differing financial instruments may count in a capital calculation. This is appropriate, as the legal framework varies in different legal systems. The theoretical reason for holding capital is that it should provide protection against unexpected losses. Note that this is not the same as expected losses, which are covered by provisions, reserves and current year profits.
In Basel I agreement, Tier 1 capital is a minimum of 4% ownership equity but investors generally require a ratio of 10%. Tier 1 capital should be greater than 150% of the minimum requirement.[cit Tier 2 capital Tier 2 capital, or supplementary capital, include a number of important and legitimate constituents of a bank’s capital base.[1] These forms of banking capital were largely standardized in the Basel I accord, issued by the Basel Committee on Banking Supervision and left untouched by the Basel II accord. National regulators of most countries around the world have implemented these standards in local legislation. In the calculation of regulatory capital, Tier 2 is limited to 100% of Tier 1 capital.
Capital Tiers and their constituents Tier
1: Core Capital
a. Paid up capital
b. Non-repayable share premium account
c. Statutory reserve
d. General reserve
e. Retained earnings
f. Minority interest in subsidiaries
g. Non-cumulative irredeemable preference shares
h. Dividend equalization account Tier
2: Supplementary Capital
a. General provision (Unclassified loans, Special Mention Account loans and off Balance Sheet exposures)
b. Revaluation reserves for fixed assets, securities and equity instruments
c. All other preference shares
d. Subordinated debt >= 5 years Tier
3: Additional Supplementary Capital (For Market Risk only)
1. Short term subordinated debt (2 years<= maturity<= 5 years)
Repurchase Agreement – Repo
A form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day. For the party selling the security (and agreeing to repurchase it in the future) it is a repo; for the party on the end of the transaction, (buying the security and agreeing to sell in the future) it is a reverse repurchase agreement. Repos are classified as a money-market instrument. They are usually used to raise short-term capital A repurchase agreement, also known as a repo and repurchase agreement, is the sale of securities together with an agreement for the seller to buy back the securities at a later date.
The repurchase price should be greater than the original sale price, the difference effectively representing interest, sometimes called the repo rate. The party that originally buys the securities effectively acts as a lender. The original seller is effectively acting as a borrower, using their security as collateral for a secured cash loan at a fixed rate of interest. A repo is equivalent to a spot sale combined with a forward contract. The spot sale results in transfer of money to the borrower in exchange for legal transfer of the security to the lender, while the forward contract ensures repayment of the loan to the lender and return of the collateral of the borrower. The difference between the forward price and the spot price is effectively the interest on the loan, while the settlement date of the forward contract is the maturity date of the loan.
Reverse Repo
A reverse repo is simply the same repurchase agreement from the buyer’s viewpoint, not the seller’s. Hence, the seller executing the transaction would describe it as a “repo”, while the buyer in the same transaction would describe it a “reverse repo”. So “repo” and “reverse repo” are exactly the same kind of transaction, just being described from opposite viewpoints. The term “reverse repo and sale” is commonly used to describe the creation of a short position in a debt instrument where the buyer in the repo transaction immediately sells the security provided by the seller on the open market. On the settlement date of the repo, the buyer acquires the relevant security on the open market and delivers it to the seller. In such a short transaction the seller is wagering that the relevant security will decline in value between the date of the repo and the settlement date.
Uses
For the buyer, a repo is an opportunity to invest cash for a customized period of time (other investments typically limit tenures). It is short-term and safer as a secured investment since the investor receives collateral. Market liquidity for repos is good, and rates are competitive for investors. Money Funds are large buyers of Repurchase Agreements. For traders in trading firms, repos are used to finance long positions, obtain access to cheaper funding costs of other speculative investments, and cover short positions in securities.
In addition to using repo as a funding vehicle, repo traders “make markets”. These traders have been traditionally known as “matched-book repo traders”. The concept of a matched-book trade follows closely to that of a broker who takes both sides of an active trade, essentially having no market risk, only credit risk. Elementary matched-book traders engage in both the repo and a reverse repo within a short period of time, capturing the profits from the bid/ask spread between the reverse repo and repo rates. Presently, matched-book repo traders employ other profit strategies, such as non-matched maturities, collateral swaps, and liquidity management. Cash reserve Ratio (CRR) is the amount of funds that the banks have to keep with the RBI.
If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI uses the CRR to drain out excessive money from the system. Commercial banks are required to maintain with the RBI an average cash balance, the amount of which shall not be less than 3% of the total of the Net Demand and Time Liabilities (NDTL), on a fortnightly basis and the RBI is empowered to increase the rate of CRR to such higher rate not exceeding 20% of the NDTL.
Merchant Bank
A bank that deals mostly in (but is not limited to) international finance, long-term loans for companies and underwriting. Merchant banks do not provide regular banking services to the general public. Their knowledge in international finances makes merchant banks specialists in dealing with multinational corporations. A merchant bank is a financial institution which provides capital to companies in the form of share ownership instead of loans. A merchant bank also provides advisory on corporate matters to the firms they lend to. In the United Kingdom, the term “merchant bank” refers to an investment bank. Merchant Banking Operations in Bangladesh A merchant bank is a financial institution which is primarily engaged in offering financial services and provides advice to corporations and to wealthy individuals.
The term can also be used to describe the private equity activities of banking. Investment Banking is an American synonym of merchant banking. Investment banks provide advice on mergers and acquisitions and are involved in financing industrial corporations through buying shares and selling them in relatively small lots to investors. In the context of Bangladesh, merchant banking includes all financial institutions that combine the functions of both development banking and investment banking. Offshore Bank An offshore bank is a bank located outside the country of residence of the depositor, typically in a low tax jurisdiction (or tax haven) that provides financial and legal advantages.
These advantages typically include:
• greater privacy (see also bank secrecy, a principle born with the 1934 Swiss Banking Act)
• low or no taxation (i.e. tax havens)
• easy access to deposits (at least in terms of regulation)
• protection against local, political, or financial instability While the term originates from the Channel Islands being “offshore” from the United Kingdom, and most offshore banks are located in island nations to this day, the term is used figuratively to refer to such banks regardless of location, including Swiss banks and those of other landlocked nations such as Luxembourg and Andorra.
Advantages of offshore banking
• Offshore banks can sometimes provide access to politically and economically stable jurisdictions.
• Some offshore banks may operate with a lower cost base and can provide higher interest rates than the legal rate in the home country due to lower overheads and a lack of government intervention.
• Offshore finance is one of the few industries, along with tourism, in which geographically remote island nations can competitively engage.
• Interest is generally paid by offshore banks without tax being deducted.
• Some offshore banks offer banking services that may not be available from domestic banks such as anonymous bank accounts, higher or lower rate loans based on risk and investment opportunities not available elsewhere.
• Offshore banking is often linked to other structures, such as offshore companies, trusts or foundations, which may have specific tax advantages for some individuals.
• Many advocates of offshore banking also assert that the creation of tax and banking competition is an advantage of the industry. What is the difference between Money Market and Capital Market? Issue of differences Money Market Capital Market Maturity Period: The money market deals in the lending and borrowing of short-term finance (i.e., for one year or less), Capital market deals in the lending and borrowing of long-term finance (i.e., for more than one year). Credit Instruments: The main credit instruments of the money market are call money, collateral loans, acceptances, bills of exchange. On the other hand, the main instruments used in the capital market are stocks, shares, debentures, bonds, securities of the government.
Nature of Credit Instruments:
The credit instruments dealt with in the capital market are more heterogeneous than those in money market. The credit instruments dealt with in the money market are less heterogeneous than those in capital market. Institutions: Important institutions operating in the’ money market are central banks, commercial banks, acceptance houses, nonbank financial institutions, bill brokers, etc.. Important institutions of the capital market are stock exchanges, commercial banks and nonbank institutions, such as insurance companies, mortgage banks, building societies, etc Purpose of Loan: The money market meets the short-term credit needs of business; it provides working capital to the industrialists.
The capital market, on the other hand, caters the long-term credit needs of the industrialists and provides fixed capital to buy land, machinery, etc. Risk: The degree of risk is small in the money market. The maturity of one year or less gives little time for a default to occur, so the risk is minimized. market The risk is much greater in capital market. Risk varies both in degree and nature throughout the capital Basic Role: The basic role of money market is that of liquidity adjustment. The basic role of capital market is that of putting capital to work, preferably to longterm, secure and productive employment. Relation with Central Bank: The money market is closely and directly linked with central bank of the country. The capital market feels central bank’s influence, but mainly indirectly and through the money market. Market Regulation: In the money market, commercial banks are closely regulated. In the capital market, the institutions are not much regulated Black Money Black money refers to funds earned on the black market, on which income and other taxes have not been paid. Proceeds, usually received in cash, from underground economic activity.
Black money is earned through illegal activity and, as such, is not taxed. Recipients of black money must hide it, spend it only in the underground economy, or attempt to give it the appearance of legitimacy through illegal money laundering. Possible sources of black money include drug trafficking, weapons trading, terrorism, and prostitution, selling counterfeit or stolen goods and selling pirated versions of copyrighted items such as software and musical recordings. Black Money is also the name of a television series hosted by Lowell Bergman that explores the secret world of bribery in international business. Money Laundering Money laundering is the process of concealing the source of money obtained by illicit means. The methods by which money may be laundered are varied and can range in sophistication. Many regulatory and governmental authorities quote estimates each year for the amount of money laundered, either worldwide or within their national economy. In 1996 the International Monetary Fund estimated that two to five percent of the worldwide global economy involved laundered money. However, the Financial Action Task Force on Money Laundering (FATF), an intergovernmental body set up to combat money laundering, stated that “overall it is absolutely impossible to produce a reliable estimate of the amount of money laundered and therefore the FATF does not publish any figures in this regard”.
Academic commentators have likewise been unable to estimate the volume of money with any degree of assurance. Regardless of the difficulty in measurement, the amount of money laundered each year is in the billions (US dollars) and poses a significant policy concern for governments.[2] As a result, governments and international bodies have undertaken efforts to deter, prevent and apprehend money launderers. Financial institutions have likewise undertaken efforts to prevent and detect transactions involving dirty money, both as a result of government requirements and to avoid the reputational risk involved. Today, most financial institutions globally, and many non-financial institutions, are required to identify and report transactions of a suspicious nature to the financial intelligence unit in the respective country. For example, a bank must verify a customer’s identity and, if necessary, monitor transactions for suspicious activity.
This is often termed as KYC – “know your customer”. This means, to begin with, knowing the identity of the customers, and further, understanding the kinds of transactions in which the customer is likely to engage. By knowing one’s customers, financial institutions will often be able to identify unusual or suspicious behavior, termed anomalies, which may be an indication of money laundering.[13]
High Powered Money
Also termed the monetary base, the total of currency held by the nonbank public, vault cash held by banks, and Federal Reserve deposits of the banks. This contains the monetary components over which the Federal Reserve System has relatively complete control and is often used as a guide for the Fed’s money control ability and monetary policy. In the context of supply of money, the concept of high powered money is more prevalent in modern time. In the context of purchasing power of money,
there are two types of money.
(1) High Powered Money
(2) Low Powered Money.
High Powered Money indicates the purchasing power of supply of money. The total purchasing power of people depends on the growth rate and quantity of total supply of money. From this point of view, money multiplier is considered in addition to quantity of currency and bank money. In short, the increase in volume of money creates purchasing power in more or less degree. The increase in supply of money that generates more purchasing power is called high powered money. Financial institutions should take high powered money into consideration to schedule stability in the country along with development.
Broad Money
In economics, broad money refers to the most inclusive definition of the money supply. Since cash can be exchanged for many different financial instruments and placed in various restricted accounts, it is not a simple task for economists to define how much money is currently in the economy. Therefore, the money supply is measured in many different ways. Broad money is used colloquially to refer to a broad definition of the money supply. In the U.S. the most common measures of the money supply are termed M0, M1, M2 and M3.
These measurements vary according to the liquidity of the accounts included. M0 includes only the most liquid instruments, and is therefore narrowest definition of money. M3 includes includes liquid instruments as well as some less liquid instruments and is therefore considered the broadest measurement of money. Complicating the situation, different countries often define their measurements of the money slightly differently. In academic settings, the term “broad money” should be separately defined in order to prevent potential misunderstandings.
Demand-Pull Inflation
Demand-pull inflation is asserted to arise when aggregate demand in an economy outpaces aggregate supply. It involves inflation rising as real gross domestic product rises and unemployment falls, as the economy moves along the Phillips curve. This is commonly described as “too much money chasing too few goods”. More accurately, it should be described as involving “too much money spent chasing too few goods”, since only money that is spent on goods and services can cause inflation. This would not be expected to persist over time due to increases in supply, unless the economy is already at a full employment level.
The term demand-pull inflation is mostly associated with Keynesian economics. Demand-pull inflation is in contrast with cost-push inflation, when price and wage increases are being transmitted from one sector to another. However, these can be considered as different aspects of an overall inflationary process: demand-pull inflation explains how price inflation starts, and cost-push inflation demonstrates why inflation once begun is so difficult to stop. Cost-Push Inflation Cost-push inflation is a type of inflation caused by substantial increases in the cost of important goods or services where no suitable alternative is available. A situation that has been often cited of this was the oil crisis of the 1970s, which some economists see as a major cause of the inflation experienced in the Western world in that decade.
It is argued that this inflation resulted from increases in the cost of petroleum imposed by the member states of OPEC. Since petroleum is so important to industrialized economies, a large increase in its price can lead to the increase in the price of most products, raising the inflation rate. This can raise the normal or built-in inflation rate, reflecting adaptive expectations and the price/wage spiral, so that a supply shock can have persistent effects. Monetarist economists such as Milton Friedman argue against the concept of cost-push inflation because increases in the cost of goods and services do not lead to inflation without the government and its central bank cooperating in increasing the money supply. The argument is that if the money supply is constant, increases in the cost of a good or service will decrease the money available for other goods and services, and therefore the price of some those goods will fall and offset the rise in price of those goods whose prices have increased.
One consequence of this is that monetarist economists do not believe that the rise in the cost of oil was a direct cause of the inflation of the 1970s. They argue that although the price of oil went back down in the 1980s, there was no corresponding deflation Bank Supervision The banking sector is an important part of the national economy. Banks take deposits, support the payment system and provide the largest source of funds on the market. Therefore, stable and safe banking are of crucial importance for the development of a safe and stable economy. The concept of centralized bank supervision, widely accepted throughout the world, is also applied in Croatia, where bank supervision is conducted by the Croatian National Bank.
The Off-Site Supervision Department
The Off-Site Supervision Department is responsible for supervising banks’ operations on the basis of data and reports submitted by banks to the Croatian National Bank pursuant to a Decision on Supervisory Reports of Banks, and on the basis of business indicators by banks. On the basis of prudential analysis of different financial indicators by banks, groups of peer banks and the banking system as a whole as well as analysis of different qualitative information, the banks are rated in terms of the level of risk involved in their business operations in accordance with the adopted methodology for analysis.
On-Site Supervision Department The responsibility for on-site supervision lies with the On-Site Risk Management Supervision Department and the Specialized On-Site Supervision Department. On-site examinations are carried out at the banks’ premises and involve examination of their business books and assessment of their technical, professional and organizational resources. Risk management function is gaining in importance in the banking sector. In addition to credit risk, banks are exposed to other risks such as: market risk, liquidity risk, interest rate risk, currency risk and a line of other risks. Their monitoring and supervision, and successful management require advanced specialized knowledge. To this end, the employees of the On-Site Risk Management Supervision Department have received specialized training for the specific risks they monitor. In addition to credit, interest rate and markets risks, which are traditionally considered typical of the banking business, on-site supervision also covers the so called operational risk which is defined as the “the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events”.
In terms of its importance, operational risk is right next to credit risk. The Specialized On-Site Supervision Department, within its assessment of the banks’ management of operational risk performs on-site examination of IT systems in banks, internal control systems, compliance with regulations, in particular supervision of the implementation of the measures of monetary and foreign exchange policy and compliance with laws and other regulations, internal procedures and payment system procedures. Fiscal policy Fiscal policy refers to the use of the government budget to influence economic activity. In economics and political science, fiscal policy is the use of government revenue collection (taxation) and expenditure (spending) to influence the economy.
[1] The two main instruments of fiscal policy are government taxation and changes in the level and composition of taxation and government spending can affect the following variables in the economy:
• Aggregate demand and the level of economic activity;
• The pattern of resource allocation;
• The distribution of income. Stances of fiscal policy The three main stances of fiscal policy are:
• Neutral fiscal policy is usually undertaken when an economy is in equilibrium. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity.
• Expansionary fiscal policy involves government spending exceeding tax revenue, and is usually undertaken during recessions.
• Contractionary fiscal policy occurs when government spending is lower than tax revenue, and is usually undertaken to pay down government debt. However, these definitions can be misleading because, even with no changes in spending or tax laws at all, cyclic fluctuations of the economy cause cyclic fluctuations of tax revenues and of some types of government spending, altering the deficit situation; these are not considered to be policy changes. Therefore, for purposes of the above definitions, “government spending” and “tax revenue” are normally replaced by “cyclically adjusted government spending” and “cyclically adjusted tax revenue”. Thus, for example, a government budget that is balanced over the course of the business cycle is considered to represent a neutral fiscal policy stance. Governments spend money on a wide variety of things, from the military and police to services like education and healthcare, as well as transfer payments such as welfare benefits.
This expenditure can be funded in a number of different ways:
• Taxation
• Seigniorage, the benefit from printing money
• Borrowing money from the population or from abroad
• Consumption of fiscal reserves
• Sale of fixed assets (e.g. land
Shares Vs Debentures
The following are the main difference between a debenture and a share:
• A person having the debentures is called debenture holder whereas a person holding the shares is called shareholder.
• Debenture holder is a creditor of the company and cannot take part in the management of the company while a shareholder is the owner of the company. It is the basic distinction between a debenture and a share.
• Debenture holders will get interest on debentures and will be paid in all circumstances, whether there is profit or loss will not affect the payment of interest on debentures. Shareholder will get a portion of the profits called dividend which is dependent on the profits of the company. It can be declared by the directors of the company out of profits only.
• Shares cannot be converted into debentures whereas debentures can be converted into shares.
• Debentures will get priority is getting the money back as compared to shareholder in case of liquidation of a company.
• There is no restriction on issue of debentures at a discount, whereas shares at discount can be issued only after observing certain legal formalities.
• Convertible debentures which can be converted into shares at the option of debenture holder can be issued whereas shares convertible into debentures cannot be issued.
• There can be mortgage debentures i.e. assets of the company can be mortgaged in favor of debenture holders. But there can be no mortgage shares. Assets of the company cannot be mortgaged in favor of shareholders.