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Executive summary
The report is about the monetary and fiscal policy and their effectiveness in the economy of
Bangladesh. The relative significance of fiscal and monetary policy has been one of the most
debated and unsettled issues in economics. The choice of optimal policy mix in developing
countries carries critical importance for their economic growth. Relevant literature shows that the
study of the effectiveness of monetary and fiscal policy is equivalent to the study of the relative
effectiveness of Keynesian economics and monetarism. Although fiscal and monetary policies
are implemented by different authorities but change in one policy musty influences the
significance of other. This study investigates the relative effectiveness of both types of policies
in the context of current situation of Bangladeshs economy. The monetary policy implemented
by the Bangladesh bank is brought about by some qualitative and quantitative measurements.
The aim is control the aggregate money supply and the demand of the people and financial
institutions. The fiscal policy focusing on the fiscal measurements such as VAT, Tax, Custom
duty, indirect policy measures etc. is implemented by the govt. to control the consumption,
growth, inflation, fair business mode etc. The effectiveness is not a immediate results of these
policies. The ultimate results are reflected throughout a balanced state of economy. There are
many repercussions of both monetary and fiscal policy of Bangladesh. From time to time there is
a need to shuffle the monetary and fiscal policy with expansionary and contractionary motive.
There lies the true effectiveness of the Monetary and Fiscal policy of Bangladesh
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Introduction

Monetary Policy the policy adopted by the central bank for control of the supply of money as an
instrument for achieving the objectives of general economic policy. With the shifts of the policy
stance of the government in various phases, necessary adjustments were made in the country's
monetary policy. The Department of Research in the Bangladesh Bank plays an important role in
the formulation of economic policies of the country.

The principal function of the Department is to help the bank in the formulation of monetary and
credit policies and also to assist it in discharging its duty as adviser to the Government on
economic and financial matters. To this end, the department keeps the top executives of the bank
fully informed of latest economic development both at home and abroad, in a regular and
systematic manner. For this purpose the Department keeps a close watch on trends in the
domestic economy as well as on international economic developments with particular reference
to monetary, fiscal and trade problems and policies. Domestic and international economic
developments are brought within the compass of comprehensive reports and reviews which are
submitted for perusal of the Governor, Deputy Governor, and Senior Executives of the bank, as
also the banks Board of Directors.
This paper reconsiders fiscal policy effectiveness in light of the recent economic crisis. It
examines the fiscal policy approach advocated by the economics profession today and the
specific policy actions undertaken by the govt. of Bangladesh. An examination of the
contemporary aggregate demand management approach wholly inadequate for achieving
certain macroeconomic objectives, such as the stabilization of investment and investor
expectations, the generation and maintenance of full employment, and the equitable distribution
of incomes. The paper reconsiders the policy effectiveness of alternative fiscal policy
approaches, and argues that a policy that directly targets the labor demand gap (as opposed to the
output gap) is far more effective in stabilizing employment, incomes, investment, and balance
sheets.

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1.1 Objective of the Study
A clear objective help in preparation of well decorated report in which other take the right type
of decision .So, we identifying objectives is very much important. Our objective of preparing the
report is:
To know about the Overview on Bangladesh economy
To know about the Importance of Monetary Rules
To know about the major Instruments Use by Bangladesh Bank
To know about the Bangladeshs Monetary Policy
To know the effectiveness of fiscal policy in shortening the duration of systemic banking
crisis episodes and strengthening economic growth in the medium term


1.2 Importance of the Study
In our Money and Baking course we will only study on our text book about the monetary policy,
but its basic implication in a country is practically unknown to us. So for gathering the practical
knowledge about monetary policy is only then can achieve, when a practical task or report will
make over it. Here our report provides information about to the monetary policy, the important
rules regarding the monetary policy, the instruments of monetary policy etc. On the second part
of our report contains the economy condition of Bangladesh as well as its monetary system. So
this report will help us to know about the monetary policy of Bangladesh at a glance with its
application.

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Bangladesh Economy
Bangladesh is primarily an agricultural country, with a growing industrial sector. The vast
majority of its inhabitants are farmers, although few of them have actual ownership over the land
that they farm. Throughout the 1980s, Bangladesh became highly dependent on foreign aid,
although this brought little real change in the lives of its people. The economy of Bangladesh is
the 31st largest economy in the world as measured by purchasing power parity (PPP). It has
made significant strides in its economic sector since its independence in 1971.
The Bangladeshi garments industry is one of the largest and most comprehensive industries in
the world. Before 1980, Bangladesh's economy and foreign exchange earnings were driven by
the jute industry. However, this industry started to fall dramatically from 1970, when
polypropylene products gained popularity over the jute products.
Current GDP per capita of Bangladesh registered a peak growth of 57% in the Seventies
immediately after Independence. But this proved unsustainable and growth consequently scaled
back to 29% in the Eighties and 24% in the Nineties.
Bangladesh has also made major strides to meet the food needs of its increasing population,
through increased domestic production. Currently, Bangladesh is the fourth largest rice
producing country in the world. The land is devoted mainly to rice and jute cultivation, although
wheat production has increased in recent years the country is largely self-sufficient in rice
production.

Nonetheless, an estimated 10% to 15% of the population faces serious nutritional
risk. Bangladesh's predominantly agricultural economy depends heavily on an erratic monsoonal
cycle, with periodic flooding and drought. Although improving, infrastructure to support
transportation, communications, and power supply is poorly developed. The country has large
reserves of natural gas and limited reserves of coal and oil. While Bangladesh's industrial base is
weak, unskilled labor is inexpensive and plentiful.

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Monetary Policy
Monetary policy, in its narrow concept, is defined as the measures focused on regulating money
supply. In harmony with monetary policy goals, the most common concept of monetary policy as
one of the central banks functions, monetary policy is defined as The set of procedures and
measures taken by monetary authorities to manage money supply, interest and exchange rates
and to influence credit conditions to achieve certain economic objectives. We find this
definition more consistent with the practical applications of monetary policy.
Monetary policy affects stock prices. We come up with a rather surprising answer, at least one
that was surprising to us. We find that unanticipated changes in monetary policy affect stock
prices not so much by influencing expected dividends or the risk-free real interest rate, but rather
by affecting the perceived riskiness of stocks. A tightening of monetary policy, for example,
leads investors to view stocks as riskier investments and thus to demand a higher return to hold
stocks. For a given path of expected dividends, a higher expected return can be achieved only by
a fall in the current stock price. As we will see, this finding has interesting implications for
several issues, including the role of stock prices in transmitting the effects of monetary policy
actions to the broader economy and the potential effectiveness of monetary policy in "pricking"
putative bubbles in the stock market. I will come back to these issues at the end of my talk. I
start, however, with the problem of measuring the effect of monetary policy on the stock market.
The effects of our policy instruments, such as the short-term interest rate, on these goal variables
are indirect at best. Instead, monetary policy actions have their most direct and immediate effects
on the broader financial markets, including the stock market, government and corporate bond
markets, mortgage markets, markets for consumer credit, foreign exchange markets, and many
others. If all goes as planned, the changes in financial asset prices and returns induced by the
actions of monetary policymakers lead to the changes in economic behavior that the policy was
trying to achieve. Thus, understanding how monetary policy affects the broader economy
necessarily entails understanding both how policy actions affect key financial markets, as well as
how changes in asset prices and returns in these markets in turn affect the behavior of
households, firms, and other decision makers.
Fiscal Policy
Fiscal policy decisions have a widespread effect on the everyday decisions and behavior of
individual households and businesses hence in this note we consider some of the
microeconomic effects of fiscal policy before considering the links between fiscal policy and
aggregate demand and key macroeconomic objectives. The proposed public finance framework
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suggests that an effort has been made to tighter the fiscal management. Experience suggests,
particularly of FY2012, that the delivery on the envisaged plan had been quite often severely
wanting. The final outcome of the fiscal framework at the end of FY2013 will depend on a
number of key questions:
Will the revenue income targets be fulfilled?
Has the revenue expenditure estimates have been correctly derived?
Can ADP implementation capacity be enhanced significantly?
Can the foreign aid awaiting in the pipeline be utilized?
Will it be possible to attract people to invest in non-bank borrowing instruments?
The prospect of the key indicators and targets mentioned in the budget for FY2013, will in all
possibility, depend on favorable answers to the aforesaid questions.
Instruments of Monetary Policy

In 1989, the government adopted a comprehensive Financial Sector Reform Programme (FSRP),
following which the country's monetary policy assumed a new orientation towards promotion of
market economy in a competitive environment. Bangladesh Bank started moving away from
direct quantitative monetary control to indirect methods of monetary management since the
beginning of 1990. Although, the fixation of target continued to remain as the central piece of
exercise, the way to achieve it had been changed. Credit ceilings on individual banks and direct
controls of interest rates were withdrawn. At present, the money supply is regulated through
indirect manipulation of reserve money instead of credit ceiling. Major instruments of monetary
control available with Bangladesh Bank are the bank rate, open market operations, rediscount
policy, and statutory reserve requirement.

The methods of credit control can be classified as follows:

a. Quantitative/ General Methods:

01. Bank rate policy
02. Open market policy
03. Variation of reserve ratio

b. Qualitative/ General Methods:

01. Rationing of credit
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02. Direct action
03. Regulation of consumers credit
04. Moral persuasion
05. Publicity
Effectiveness of Monetary policy
Monetary policy aims and methods have changed over time. Both in developed and developing
economies, monetary policies seek to maintain price stability by sustained stable output growth
in the face of internal and external shocks that are faced from time to time.

In developed economies with production factors at or close to full employment, monetary
policies are formulated typically with the output gap (difference between the actual and the
longer run potential output) in view; the policy stance is eased to provide stimulus at times of
slowdown when actual output lags the longer run potential, and the stance is tightened to slow
things down when the economy overheats with actual output running ahead of the sustainable
longer run potential.
Diagnosing and treating asset price bubbles symptomatic of overheating are major issues of
current debate in monetary policy.

For developing economies like Bangladesh with significant underemployment/ under
exploitation of production factors, stimulating higher growth is imperative for rapid reduction
and eventual elimination of endemic poverty, and is therefore an overriding priority. The
stimulus provided by monetary policies in accommodating the growth aspirations must not
however over step towards macroeconomic imbalance destabilizing and jeopardizing future
growth; and the pursuit of monetary policies comprise the continual balancing act of supporting
the highest sustainable output growth while adjusting smoothly to internal and external shocks
that the economy encounter from time to time.

The primary objective of the Monetary Policy of Bangladesh is to outline the formulation and
implementation of monetary policy of the Bangladesh Bank (BB), and to convey its assessment
of the recent and the expected monetary and inflation developments to the stakeholders and the
public at large.

The Bangladesh Bank Order of 1972 outlines the main objectives of monetary policy in
Bangladesh, which comprises

To achieve the price stability
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To regulate currency and reserves
To promote and maintain a high level of production, employment and real income, and
economic growth, since independence BB operated under a variety of pegged exchange
rate systems amid capital controls

To manage the monetary and credit system
To maintain the par value of domestic currency
To promote growth and development of the country's productive resources in the best
national interest
Although the long term focus of monetary policy in Bangladesh is on growth with
stability, the short-term objectives are determined after a careful and realistic appraisal
of the current economic situation of the country.

In effect, the exchange rate served as a nominal anchor, with the ultimate goal of maintaining
price stability. However, prices of non-tradable goods, given the latters high share in national
expenditure, dominated the inflation behavior. Indeed the prevailing exchange rate during the
1970s and 80s remained mostly overvalued which was also accompanied by high (typically
double digit) inflation
Rationality of monetary policy of Bangladesh bank: Bangladesh Monetary Aggregates:
Targets and Developments
(Half Yearly Growth Rates)
FY10(Dec) 2011(June) 2011(Dec) 2012(Jun)
Target Actual Target Actual Target Actual Target
1. Net Foreign Asset 4.2 14.2 4.2 5.2 -1.6 -8.6 -8.9
2. Net Domestic
Assets
17.6 23.4 17.6 25.0 22.1 22.9 21.9
Domestic credit 17.9 24.4 17.9 27.4 20.0 25.7 19.1
Credit to the pub.
sec.
25.3 12.0 25.3 33.6 28.1 62.0 31.0
Credit to the pvt.
Sec.
16.0 27.6 16.0 25.8 18.0 18.0 16.0
3. Broad money 15.2 21.7 15.2 21.3 18.5 17.4 17.0
4. Reserve money 13.0 20.7 13.0 21.1 16.0 12.5 12.2


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Price stability

Inflation distorts economic calculations and expectations while deflation creates depression in
the economy. Thus price stability should be the main aim of monetary policy. Price stability
promotes business confidence, makes economic calculation possible, controls business cycle and
introduces certainty in economic life.

Be that as it ma, it must be admitted that price stability does not be necessarily mean absolute
constancy of price level. A very slow rising price level (or mild inflation) may have all the
virtues of a stable price level, which can contribute more directly to economic growth.


Exchange Stability

Maintenance of stable exchange rates is an essential condition for the creation of international
confidence and promotion of smooth international trade on the largest scale possible. A
restrictive monetary policy trends to reduce a countrys balance of payment defect in the
following ways:


It tends to reduce demanding the country, which in turn tends to reduce the demand for imports
as well as for domestic goods.

Reduction in domestic demeans holds down the rate of inflation or reduces prices which makes
imported articles less attractive and makes the defect countrys exports more attractive to
foreigners. Thus, import is curtailed and export expanded.

Under dear money policy, higher interest rates make it less attractive for foreign countries to
borrow from the defect country and induce them to invest there.


Full Employment

In under developed countries, the full employment objective is more crucial, because such
economies have both unemployment and under employment open and disguised. In less
developed countries, though full employment cannot be achieved within a short period, the
monetary policy should try to achieve at least a near full employment situation. Full
employment objective of monetary policy has certain far-reaching beneficial effects:
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Full employment can maintain a high level of aggregate effective demand, and thereby can
iron out cyclical fluctuations, stagnation and under consumption trap.

Before full employment is achieved, investment can be made in excess of saving and a price
increase in a slow rate is permissible. These will give incentive for the fuller utilization of
resources and for higher income, output and employment.

The creation of full employment condition will almost automatically, lead to the maximization
of social and economic welfare of the society because the resources would be used fully and
effectively.

Full employment will, according to Einzig, lead to increase productivity of workers, because
the workers are not sacred of unemployed situation. The relation between labor and capital
would be ideal and all-round efficiency will increase.

Economic Growth

This comparatively a recent object of monetary policy. If refers to the growth of real income or
output per capita. Monetary policy can contribute to economic growth in the following ways:

It can maintain a balance between monetary demand and supply of goods, and it can also
supply money is such a way as is consistent with the supply of goods and services.

It can create atmosphere in which a higher rate of saving and investment would be generated.

Monetary policy minimizes fluctuation in business activity and prices.

It creates stability for growth.

It influences the rate of interest, investment and the use of credit in the most productive
channels in the economy.

When necessary, it expands credit and when it is not necessary, if restricts the flow of credit. It
creates saving intuitions and monetization in the saving of the community towards productive
investment.

Monetary policy gives guidance, looks after monetization in the unorganized sector and
controls the actives of the financial intermediaries.
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Neutrality of Money

Neutrality of money indicates a situation in which changes in the quantity of money occurs in
such a way as to cause a proportionate change in the equilibrium prices of commodities, and the
equilibrium rate of interest remains unchanged. If money is neutral, an increase or decrease in
the quantity of money will both produce and disturbing effects in the economy. Neutrality of
money does not mean constant money supply, means that the effect of changed money supply on
real variables in the economy would be neutral.

Balance of Payment Equilibrium
Balance of payment equilibrium condition is a position at which a country repaid its debts and
has attained an adequate reserve at zero balance over time. This main objective on monetary
policy has become significant in the pose-period. It is realized that the existence of balance of
payment deficit seriously reduces the ability of an economy to attain other objectives. So,
monetary policy must make into consideration the international payment problem.
Effectiveness of Fiscal Policy
The fiscal frame work of the govt. is presented below with the key sectors involved
in the fiscal mechanisms.

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Taxation and work incentives
Can changes in income taxes affect the incentive to work? This remains a controversial subject
in the economic literature!
Consider the impact of an increase in the basic rate of income tax or an increase in the rate of
national insurance contributions. The rise in direct tax has the effect of reducing the post-tax
income of those in work because for each hour of work taken the total net income is now lower.
This might encourage the individual to work more hours to maintain his/her target income.
Conversely, the effect might be to encourage less work since the higher tax might act as a
disincentive to work. Of course many workers have little flexibility in the hours that they work.
They will be contracted to work a certain number of hours, and changes in direct tax rates will
not alter that.
The government has introduced a lower starting rate of income tax for lower income earners.
This is designed to provide an incentive for people to work extra hours and keep more of what
they earn. Changes to indirect taxes in particular can have an effect on the pattern of demand
for goods and services. For example, the rising value of duty on cigarettes and alcohol is
designed to cause a substitution effect among consumers and thereby reduce the demand for
what are perceived as de-merit goods. In contrast, a government financial subsidy to
producers has the effect of reducing their costs of production, lowering the market price and
encouraging an expansion of demand.
The use of indirect taxation and subsidies is often justified on the grounds of instances of market
failure. But there might also be a justification based on achieving a more equitable allocation of
resources e.g. providing basic state health care free at the point of use.
Taxation and labor productivity
Some economists argue that taxes can have a significant effect on the intensity with which
people work and their overall efficiency and productivity. But there is little substantive empirical
evidence to support this view. Many factors contribute to improving productivity tax changes
can play a role - but isolating the impact of tax cuts on productivity is extremely difficult.
Taxation and business investment decisions
Lower rates of corporation tax and other business taxes can stimulate an increase in business
fixed capital investment spending. If planned investment increases, the nations capital stock can
rise and the capital stock per worker employed can rise.
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The government might also use tax allowances to stimulate increases in research and
development and encourage more business start-ups. A favourable tax regime could also be
attractive to inflows of foreign direct investment a stimulus to the economy that might benefit
both aggregate demand and supply. The Irish economy is often touted as an example of how
substantial cuts in the rate of corporation tax can act as a magnet for large amounts of inward
investment. The very low rates of company tax have been influential although it is not the only
factor that has underpinned the sensational rates of economic growth enjoyed by the Irish
economy over the last fifteen years.
Capital investment should not be seen solely in terms of the purchase of new machines. Changes
to the tax system and specific areas of government spending might also be used to stimulate
investment in technology, innovation, the skills of the labour force and social infrastructure. A
good example of this might be a substantial increase in real spending on the transport
infrastructure. Improvements in our transport system would add directly to aggregate demand,
but would also provide a boost to productivity and competitiveness. Similarly increases in capital
spending in education would have feedback effects in the long term on the supply-side of the
economy.
Fiscal Policy and Aggregate Demand
Traditionally fiscal policy has been seen as an instrument of demand management. This means
that changes in spending and taxation can be used counter-cyclically to help smooth out some
of the volatility of real national output particularly when the economy has experienced an
external shock.
Discretionary changes in fiscal policy and automatic stabilizers
Discretionary fiscal changes are deliberate changes in direct and indirect taxation and govt
spending for example a decision by the government to increase total capital spending on the
road building budget or increase the allocation of resources going direct into the NHS.
Automatic fiscal changes are changes in tax revenues and government spending arising
automatically as the economy moves through different stages of the business cycle. These
changes are also known as the automatic stabilizers of fiscal policy
Tax revenues: When the economy is expanding rapidly the amount of tax revenue increases
which takes money out of the circular flow of income and spending
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Welfare spending: A growing economy means that the government does not have to spend as
much on means-tested welfare benefits such as income support and unemployment
benefitsBudget balance and the circular flow: A fast-growing economy tends to lead to a net
outflow of money from the circular flow. Conversely during a slowdown or a recession, the
government normally ends up running a larger budget deficit.





Figure depicts in various tax growth structures in the economy
Growth in total tax revenue has fallen to 15.18% on 2009-10 from 18.28% in 2008-09
Growth in income tax 2009-10: 22.32% and 2008-09: 23.02% (minimal decrease)
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Growth in VAT 2009-10: 13.32% and 2008-09: 18.24% (decrease)
Growth in import duty: 2009-10: 9.56% and 2008-09: 2.9% (increase)
Growth in excise duty 2009-10: 10.13% and 2008-09: 11.27% (decrease)
Growth on supplementary duty 2009-10: 19.95% and 2008-09: 14.44% (increase)

Impact of fiscal policy on the composition of output
Monetary policy is often seen as something of a blunt policy instrument affecting all sectors
of the economy although in different ways and with a variable impact. Fiscal policy changes can
to a degree be targeted to affect certain groups (e.g. increases in means-tested benefits for low
income households, reductions in the rate of corporation tax for small-medium sized enterprises
and more generous investment allowances for businesses in certain regions)

Conclusion
This paper examines the relative effectiveness of both types of policies in the context of modern
time series econometrics in case of Bangladesh during the period from 1990 to 2007. Money
supply appeared as a significant variable in both short run as well as in long run, Fiscal policy
also appears as effective in the medium term and long term time frame. The combined effort of
Bangladesh Bank and Government has been focused on the stabilization of the public welfare
and the national growth.

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References


1. Banglapedia_allbd.com, use Subject: Ref-Banglapedia.SBD M_0309.htm


2. Bangladesh Bank, Monetary Policy Statement, J anuary, 2006

3. www.cpd-bangladesh.org

4. Akram, Tanweer; "Bangladesh's Privatisation Policy", J ournal of Emerging
Markets, Volume 4, No. 2, Centre for Global Education, New York, USA, 1999.


5. Annual Report 2000, The Dhaka Chamber of Commerce and Industry

6. Bakht, Zaid; Preparation of the Sixth Fiver Plan: Position paper on Industry,
January, 2001

7. Bangladesh Economic Review 1999, Ministry of Finance, Government of
Bangladesh.

8. Bangladesh: Key Challenges for the Next Millennium, The World Bank, April, 1999

9. Centre for Policy Dialogue (CPD), "Changes and Challenges: A Review of
Bangladesh's Development 2000"



10. Ajayi, S.I. (1974). An Econometric Case Study of the Relative Importance of
Monetary and Fiscal Policy in Nigeria. The Bangladesh Economic Review, Vol. 2,
No. 2. 559-576.