CHAPTER 4 role of government

By: CIK MASLIZA MAZLAN

Relate the role of government in the context of
Macroeconomics

• Explain the types of budget
• Explain the sources of government revenue
• Explain the types of government expenditure
• Explain the sources of public debt

Explain the government policy

• Define the government monetary policy, fiscal policy and direct control
policy

• Explain the types of government monetary policy and fiscal policy
• Describe the tools of government monetary policy, fiscal policy and

direct control policy

 The Gov plays an important role in ensuring the
stability and economic growth of a country

◦ Gov will provide a legal framework and a social
framework for the effective operation of an
economy

◦ Creating a business environment that promotes
healthy competition

◦ Redistribution and reallocation of income and
wealth

◦ Increasing the efficiency of the allocation of
resources

◦ Creating a stable economic environment
◦ Controlling the proce of necessity goods
◦ Increasing a government welfare activities

 Def: a document containing a preliminary

approval plan of public revenue and
expenditure in a year

3 type of budget:-
Balanced budget : the government’s total
expenditure is equal to its total revenue
Surplus Budget : the government’s total revenue
is more than its total expenditure
Deficit Budget : the government’s total
expenditure is more than its total revenue

i. Tax Revenue

 Tax is a compulsory contribution by an individual or a
firm to the Gov to be used in the common interest of
the economy

 Tax is a contribution to the revenue of the Gov so that
the Gov can provide the necessary administrative
services to the govern the country

 Direct Tax : Tax paid by the person on whom it is

levied which cannot be passed on to another
person

 Example : individual income tax, companies’ income tax,

stamp duties, petroleum income tax etc.

 Indirect Tax : burden of tax can be passed on to

another person/party

 Example : Import duties, excise duties, sales tax etc.

ii. Non-tax Revenue

 Revenue which arise from other sources
beside tax

 Revenue not generated from tax
 Example : sales of government asset,rental of

government property,fees for issue licenses
and permits, interest and returns on
government investment,petroleum royalty,
penalties, fines,fees and penalties,
contributions from foreign governments and
cash royalty from petroleum and gas.

Income
Equitable distribution of income
Reduction of harmful consumption
Regulation of Foreign Trade
Conversation of resources

Proportional
Progressive
Regressive

 a tax rate which is imposed at the same rate for all
income levels

 remains constant regardless of whether income
increases or decreases

Income (RM) 500 1000 1500 2000
Total taxes (RM) 25 50 75 125
Tax rate 5% 5% 5% 5%

Tax rate (%)

Income (RM)

 a tax rate goes on increasing with income.
 the higher the income, the higher the percentage

of tax
 can be charged to obtain revenue to help the poor

Income (RM) 500 1000 1500 2000
Total taxes (RM) 25 80 150 240
Tax rate 5% 8% 10% 12%

Tax rate (%)

Income (RM)

 a tax rate which falls with an increase in income.

 the higher the income, the lower the percentage of
tax

Income (RM) 500 1000 1500 2000
Total taxes (RM) 50 80 90 80
Tax rate 10% 8% 6% 4%

Tax rate (%)

Income (RM)

The table below shows the total tax paid by individuals in
Australia and New Zealand at different income level

Australia Income 1,000 2,000 3,000 4,000
level ($) 60 180 360 600
New
Zealand Tax paid 8,000 11,000 12,000 15,000
($) 480 660 720 900

Tax rate

Income
level ($)

Tax paid
($)

Tax rate

i) Calculate the tax rate for each at every income level country
ii) Determine the tax structure adopted by each country

 2 categories of government expenditure:

i. Government Operating or Management
Expenditure
 allocated to cover the expenses of operating
and administering government department.
 consists of emoluments, pensions and
gratuities, debt, services changes, supplied
and services, subsidies, asset acquisitions,
grants and transfers and other expenditure.



ii. Government Development Expenditure

 Government expenditure for investment
purpose to improve facilities in the basic
physical infrastructure.

 focused on development projects that can boost
economic growth

 consists:-

a. defence and security

b. economic services – agriculture and rural
development, trade and industry, transport,
public utilities, etc.

c. social services – education, health, housing
and social community services

d. general administration –Department of
Public Services (JPA), Inland Revenue
Department (LHDN), Royal Customs and
Excise, Department of Statistics



 Internal sources

Borrowing from citizens : the sale of

securities, bonds and saving
certificates to citizens

Borrowing from financial institutions :

insurance companies by investing their
resources in the purchase of
government securities

Loans from the Central Bank : the

central bank purchase government
securities, bonds and debentures from
the government.

Loan from commercial banks : the

commercial bank invest a part of their
deposits in government bonds and
securities to fulfill liquidity
requirements.

 External Sources

 International money market : some foreign

exchange banks which have big deposits to lend
any government requesting loans

 Currency loans from foreign government : USA,

UK, Germany and Japan for the supply of needed
goods

 Loans from international financial institution :

 IMF gives loans to its members on a short-term basic
 World Bank gives long-term loans for economics

development on a reasonable rate of interest.

Fiscal Policy

 the use of government taxation and expenditure to
influence the country’s spending, employment and
price levels.

 Objective:-
• Securing efficient allocation of economic
resources
• Attaining and maintaining full employment
• Accelerating the rate of economic growth
• Controlling the equitable distribution of income
and wealth

 Expansionary  Contractionary

 adopted to overcome  adopted to overcome
unemployment or inflationary problems.
recession problems
 in inflation, the
 in recession, economy appropriate fiscal policy
suffers from rising is to create a budget
unemployment, falling surplus in order to
income and shrinking reduce aggregate
economy activities spending

 Gov will increase public  Gov will increase of
spending by taxes and reduction of
undertaking public government spending
works program and
reduce taxes

Discretionary Automatic

o to changes in government o Changes in government
expenditure and taxes to control expenditure and taxes which
unemployment or inflation occur automatically without any
government action
 Government expenditure
• Unemployment : the Gov will  Transfer payment
increase its expenditure .  Unemployment / Deflation:
• Inflation : the Gov will reduce increase transfer payments
its expenditure  Inflation : decrease transfer
payment
 Taxes
 Unemployment : the Gov will  Personal Income Tax
decrease tax rates • Unemployment : decrease
 Inflation: the Gov will increase personal income tax
taxes • Inflation: increase
personal income tax

 A policy employing the central bank’s control of the supply
of money

i. Quantitative Monetary Policy

1. Statutory Reserve Requirements
 A percentage of total deposits in commercial banks
that must kept in the Central Bank
 Inflation SRR the ability of commercial banks to
provide loans will decrease. The supply of money in
the economy will also decrease
 Deflation : SRR

2. Minimum Liquid Requirements
 Minimum amount of liquid assets compulsorily kept
by the commercial banks and financial companies
 Inflation : MLR to decrease the ability of
commercial banks to provide loans
 Deflation : MLR

3. Open Market Operation

 The sale and purchase of government guarantee

letters in the open market

 From this process, commercial banks can directly

control the bank reserves, credit flow and stocks of
money in the commercial banks

 Inflation : selling bonds / government guarantee letters
 Deflation : purchasing bonds / government guarantee

letters

4. Bank Rates or Discount Rates
 The minimum interest that a commercial banks needs to
pay to the Central Bank if the commercial banks wishes
to make a loan from the Central Bank
 Inflation: BR / DR to decrease the ability of commercial
bank to provide loans.
 Deflation : BR / DR

5. Interest Rates
 Can be used to influence the cost of borrowing for
consumption
 Inflation: when money supply decrease, high interest
rates might be seen as requirement for controlling
consumer spending
 Deflation : when money supply increases, a lower
interest rate means that it is cheaper to borrow money.

6. Funding

It is a process where government sells long-dated
debt (national savings security) rather than short
dated debt (treasury bills)

Inflation : managing government debt by
replacing short-term securities with longer term in
order to influence money supply

ii. Qualitative Monetary Policies

1. Selective credit controls:

Mortgage controls

Commercial banks controls on loans that involve the
sale and purchase of the housing assets

Inflation : CB prevent people from buying assets

Unemploment: CB encourage people to buy assets
Credit installments

controls on the total down payment period for loans to
purchase assets

Inflation :CB prevent people from buying cars on credit
installment

Unemployment : CB encourage people o buy cars on
credit installment

2 Moral persuasion

 Direct meetings between the Central Bank with
commercial banks to explain the economics goals
and government policies and to persuade
commercial banks to implement the appropriate
steps for the success of the economic goals and
government policies.

Unemployment
 Disseminate labor market information
 Increase labor mobility
 Creation of new employment opportunities
 Encourage foreign investment
 Upgrade skills and technical education and

retraining
 Increased investment in worker training
 Creation of more employment opportunities in

various economic sectors
 Diversify economic activity
 Development of new land
 Family planning in long run
 Modernization of agriculture sector
 Improve level of education

Inflation
 Price control
 Rationing
 Anti-hoarding campaign
 Compulsory savings
 Increase the production of necessity goods
 Controlling the increase of salary and wages
 Controlling prices of raw material
 Reduction of import tax on intermediate

goods
 Diversifying sources of imports
 Strengthening currency value to reduce the

cost of imports