Mary: Thank you, Dima, out first point will be to define fiscal policy which refers to a governments taxation

and spending plans. It is suggested that every government should achieve a balanced budget. However, it can decide to run either a deficit or a surplus. But I really dont understand, why is it good to have expenditures higher than income? Pavel: Running a budget deficit is frequently used to promote economic growth and reduce unemployment. So, by running a budget deficit, the government is injecting more into the economy than it's taking out and can boost aggregate demand and reduce unemployment. This is known as an expansionary policy. But its not the only way to combat inflation. Mary: Fiscal policy can also be used to control inflation. If an inflationary gap exists, government should reduce aggregate demand by running a budget surplus and this way take money out of the economy. Dima: Ok, guys, as far as I know, there is one more way the government can impact on the economy. That is monetary policy. Can you give some details about it? Pavel: Well, monetary policy refers to the management of the money supply in the economy. It can involve changing interest rates, setting reserve requirements for banks, or trading in foreign exchange markets. And Mary will tell us more. Mary: The first instrument of governmental monetary policy is imposing reserve requirements which can be understood as the proportion of deposits in banks retained in cash. Its relevant to say that this direction of the policy is implemented quite rarely, all developed countries prefer to use the interest rate change. High interest rates restrict money demand because of the increased costs of borrowing. Some time later the economy reacts to this elimination by contracting. Lets now talk about open market operations. By buying and selling its own bonds the government can be able to control the money supply. You may ask me: How does it work? And you will hear the explanation right now! When the government sells bonds it receives cash in return, this way reducing the amount of money in circulation. Pavel: Lets move on and mention that monetary policy can be described as expansionary or contractionary. The first one increases the total supply of money in the economy, the second is the opposite. Expansionary policy is used to combat unemployment by lowering interest rates, the contractionary is used to combat inflation by raising interest rates. Mary: So, every country can decide what methods to use, but generally, there are three main theories how to manage the economy. Can you tell some about the first one? Pavel: Classic theory approach is a *leave it alone*, do nothing. In the event of depression the price of factors of production would fall. This would increase demand for them and re-establishment of economic growth. But this theory was severely challenged by the Great Depression in the 1920s and 30s when the economy seemed unable to grow itself. Out of this failure grew John Keynes' approach. Mary: Oh, its my theme! Keynes believed that the economy could become stuck at the equilibrium points which didnt necessary involve full employment. By borrowing money and injecting them to stimulate the economic growth the government can lead the economy to the equilibrium. For example, if an economy was growing too fast and experiencing inflation,

government should increase levels of taxation, this way reducing the amount of money in it. Finally, Keynes was for management of the aggregate demand or demand side economics. As far as the Keynesian theory is concerned, its quite hard not to remember about monetarists. Do you want to come in here? Pavel: Thats the field Im comfortable with. Monetarists believe that there is the only equilibrium point when supply is equal to demand in all markets in an economy. The role of government is to remove market imperfections such as: -inflation; -government spending and taxation; -price fixing; -minimum wage agreements; -regulation of markets; -abuses of monopole power. Monetarist solutions are often described as supply side economics as they focus on improving the supply of factors of production. Thats all. Dima: thank you so much for this part, I think everyone would be interested in the way who do convenient economic theories applied this instruments, I mean classic, Keynesian and monetary.